What type of loss may only be deducted against passive income?

The deduction of passive losses is specifically structured to offset passive income. Passive income generally includes earnings from rental activities and business operations in which the taxpayer does not materially participate. The tax code restricts the use of passive losses, particularly to ensure that individuals cannot use these losses to offset other types of income, such as active income earned from wages or capital gains.

In this context, passive losses arise when allowable expenses from passive activities exceed the income generated by those activities. The tax law limits the extent to which these losses can be used, typically allowing them to only reduce income from other passive activities or to be carried forward to future tax years when there may be passive income available to offset.

Understanding this structure helps clarify why passive losses cannot be utilized in conjunction with active losses, portfolio losses, or capital losses. Each of these loss types has its own set of rules and implications for tax liability, underscoring the specific nature of passive losses and their relationship with passive income.