Dear Tax Talk,

I have two unincorporated businesses, two Schedule Cs. One business, software consulting, is highly profitable. The other business, real estate consulting, is losing money. Could I deduct losses of the real estate business from the profits of the software consulting?

— LK

Dear LK,

I guess it’s a bad time even to be consulting about real estate. When you prepare your tax return, you are completing a separate Schedule C for each of the activities.

You generally would complete a separate Schedule C when your revenue sources come from distinct activities. You should refer to the principal business activity codes in the Schedule C instructions on how to distinguish one activity from the other.

For example, activity code 541600 covers management, scientific and technical consulting services. This code may be sufficiently broad to encompass your real estate and software consulting services as one activity. If this is the case, you could eliminate the need to file separate Schedule Cs.

Although one activity code may cover all your functions, you may want to continue to file separately if, for example, you have separate bank accounts for the businesses.

Either way, generally you would combine the net income or loss of both Schedule C activities and carryover the net result to line 12 of Form 1040, and also the Schedule SE.

The principal exception to using a loss from one activity to offset income from another involves the passive activity rules. A passive activity for this purpose is a trade or business activity in which you do not materially participate during the year. Under these rules, only losses are limited; net income is always includable.

There are seven tests to determine material participation in trade or business. Based on your question, it would seem that if the real estate consulting business can pass the following two tests, there would not be a passive activity issue.

You are considered to materially participate if:
  1. You participated in the activity for more than 500 hours.
  2. Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who did not own any interest in the activity.

For example, even though you may not reach the 500 hours due to a lack of business, you could still meet the test if you performed substantially all the activities of the business. If the real estate business does not fall within these parameters, you may want to review Publication 469 for more information on passive activity losses.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.

Promoted Stories