Intuit Academy Tax Practice Exam 2025 - Free Tax Practice Questions and Study Guide

The definition of "passive activity loss" refers specifically to losses incurred in activities in which the taxpayer does not materially participate and which cannot be used to offset ordinary income. This concept typically relates to income generated from rental properties or certain businesses in which the taxpayer is not actively involved on a regular, continuous, or substantial basis.

By classifying these losses as passive, the tax code imposes limitations on the deductibility of these losses against other types of income, particularly ordinary income like wages or salaries. This ensures that the tax benefits associated with passive investments are not as readily available as those generated from active participation in a trade or business.

In contrast, other options would not accurately capture the nuances of how passive activity losses are treated under tax regulations. For example, losses that offset ordinary income (which is mentioned in one of the choices) typically characterize active losses, not passive ones. Furthermore, losses generated in non-rental activities (another option) fail to recognize that passive losses can occur specifically in rental activities. Similarly, stating that losses are fully deductible against ordinary income ignores the restrictions placed on passive activity losses. Thus, the correct characterization of passive activity loss as losses from rental or business activities that cannot offset ordinary income properly reflects the tax principles governing