Taxes
Passive Activity Investments Can be a PIG Deal
This technique can be especially beneficial at the end of the year when you may be looking to offset highly-taxed income.
Nov. 03, 2023
When You Should PIG Out
It’s not greedy to use a “pig” when you’re talking about investment strategies designed to reduce income tax liability. In this instance, the term refers to a “passive income generator” (PIG). Depending on your situation, you might invest in a PIG to maximize the tax benefits.
Briefly stated, income from a PIG can absorb prior passive activity losses and is essentially tax-free up to the amount of the total loss, despite certain tax law restrictions. This technique can be especially beneficial at the end of the year when you may be looking to offset highly-taxed income.
Background: The so-called passive activity loss (PAL) laws were enacted back in the eighties to deter high-income investors from using losses from tax shelters—such as oil and gas drilling and cattle breeding deals—to claim large losses in the early years of ownership. As a result of those tax shelter deals, it was possible for wealthy individuals to cut their tax bills to little or even nothing.
Under the tax law crackdown, you can only use losses from passive activities incurred during the year to offset income from activities received during the same year. Any excess loss from your passive activities can’t offset other highly-taxed non-passive income like salary or regular business income. These PALs are suspended indefinitely until a year in which you have passive income.
The definition of a “passive activity” is broad. It includes any kind of trade or business in which you do not “materially participate.” For example, if you invest in an oil and gas or cattle breeding deal through a limited partnership, it’s treated as a passive activity.
Note that rental real estate is automatically considered to be a passive activity although special tax law provisions provide partial benefits to certain real estate investors and full benefits for real estate professionals. Another exception applies to a “working interest” in oil and gas (e.g., where you actually do work in the field).
But the passive activity rules resulted n a new form of ta shelter. Instead of a partnership that provides desired tax losses, a PIG, as the name suggests, is intended to start churning out income right away. Thus, when you invest in a PIG you can realize current income that soaks up suspended PALs.
PIGs are marketed by various sponsors and brokers. They can run the gamut from ski resorts to conference centers to golf courses. But be wary about come-ons from aggressive promoters who may be trying to scam you out of your funds. If something sounds too good to be true, it probably is.
Practical advice: Investigate these investments carefully. In the process, don’t hesitate to seek guidance from your professional advisors.