The problem
Transferable clean energy credits can reduce federal income tax, but the passive activity rules in IRC §469 can limit whether a purchased credit is usable by a taxpayer in the current year. This comes up for individuals, trusts and estates, and certain corporations (including closely held C corporations and personal service corporations). It also comes up in “business” contexts because partnerships and S corporations pass items through to owners, and the passive vs. non-passive limitation is applied at the owner level.
The framework that controls the answer
For this question, “passive vs. active” is determined almost entirely under §469, with transferability under §6418 layered on top.
1) Start by sorting income into §469 buckets
- Non-passive (often called active): income from a trade or business where there is material participation.
- Passive: income from a trade or business without material participation, plus rental activity (generally passive unless an exception applies).
- Portfolio: investment income is often not passive for §469 purposes, which is one reason why high-income taxpayers often have little passive income tax liability.
2) Use the definition that matters
An activity is generally passive if there is no material participation. Material participation means involvement that is regular, continuous, and substantial.
3) Run the material participation tests (high level)
The IRS provides seven tests. Meeting any one generally makes the activity non-passive. Common triggers include:
- 500+ hours in the activity, or
- 100+ hours and no one else participates more, or
- participation is substantially all participation, or
- prior-year participation tests apply, or
- facts and circumstances support regular, continuous, and substantial participation (with limits)
4) Treat rentals as a separate rule set
Rental activity is generally passive regardless of participation, unless a narrow exception applies (for example, real estate professional rules). Do not assume time spent on rentals changes the passive classification.
5) Grouping can change the outcome
Grouping activities can affect whether material participation thresholds are met, but grouping must be defensible and consistent.
How this connects to transferred credits under §6418
IRS guidance warns that taxpayers who are subject to §469 can face passive activity limitations for transferred credits, which can limit use to passive tax liability. Commentary on the final transferability rules indicates transferred credits are treated as arising from a passive activity if the transferee does not materially participate in the credit-generating activity, with a limited exception discussed where the transferee owns an interest in the transferor’s trade or business at the time relevant work is performed and is not automatically deemed to fail the material participation requirement. However, this §469 exception can lead to a “catch-22,” because §6418 contains restrictions concerning transfers to related parties.
The decision point before buying credits
- If the transferred credit is treated as passive, is there enough passive tax liability to use it this year?
- If not, does it still make sense if the credit is suspended and carried forward under §469?
- If non-passive treatment is expected, is there a real, supportable basis for material participation tied to the underlying activity, supported by documentation?
Bottom line
Do not assume a transferred credit will offset any type of tax liability. Start with §469 classification, determine passive capacity, and only then evaluate whether a transferred credit purchase achieves the intended current-year tax result.
This Explanation Does Not Constitute Tax Advice – Please note that information provided in this Explanation is general in nature, and application of the tax code and regulations to specific facts may differ from the general statements made in this Explanation. Accordingly, anyone selling or purchasing renewable energy tax credits is encouraged to retain their own tax advisor(s).
