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A tax shelter is an investment that usually requires substantial contributions with a degree of risk. It often involves current losses to produce future gains. An investment in low income property that provides depreciation benefits is one example of a legitimate tax shelter. Generally, the amount of your deductions or losses from most activities is limited to the amount that you have at risk.
You are considered at risk in an activity for the following amounts:
- The amount of cash you invested in the activity,
- The adjusted basis of other property you contributed to the activity; and
- The amount you borrowed to invest in the activity, to the extent that you are personally liable on the loan or have pledged property not used in the activity as security.
For more information on the at risk rules, refer to Publication 925, Passive Activity and At Risk Rules.
Note: Tax shelter trade or business activity losses or credits are often considered passive activity losses or credits. Such losses or credits may only be used to offset income from other passive activities. They cannot be deducted against other income such as wages, salaries, professional fees, or portfolio income such as interest and dividends. Allowable losses or credits are computed on Form 8582 (PDF), Passive Activity Loss Limitations.
The excess passive losses and credits generated from passive activity tax shelters can be carried forward until you can use them or until you dispose of your investment in the tax shelter.
For more information on passive income and losses, refer to Topic 425, Passive Activities Losses and Credits or to Publication 925.