J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

10.16 Sales of Property and of Passive Activity Interests

Gain on the sale or disposition of property is generally passive or nonpassive, depending on whether your activity is passive or nonpassive in the year of sale or disposition. Thus, gain on the sale of property used in a rental activity is generally treated as passive income, as is the gain on property used in a nonrental business if you did not materially participate in the business in the year of sale. On the other hand, gain on the sale of property is generally nonpassive if the property was used in a business that you materially participated in during the year of sale. However, exceptions described below may change this treatment.

Where you transact an installment sale, treatment of gain in later years depends on your status in the year of sale. For example, if you were considered a material participant in a business, all gain is treated as nonpassive income, including gain for later installments. If you were in a rental activity or were not a material participant in a nonrental business, the gain is treated as passive income, unless the exceptions in this section apply.

Gain on substantially appreciated property formerly used in nonpassive activity.

Even if an activity is passive in the year that you sell substantially appreciated property, gain on the sale is treated as nonpassive unless the property was used in a passive activity for either 20% of its holding period or the entire 24-month period ending on the date ...