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Passive Activity Losses and At-risk Limitations

Passive Activity Losses and At-risk Limitations. Laws derived from tax shelter problems of the 1980s. At-risk Limitations . Tax shelter deductions in total are limited to amount taxpayer is at risk if shelter is a financial disaster and recovery is not possible

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Passive Activity Losses and At-risk Limitations

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  1. Passive Activity Losses and At-risk Limitations Laws derived from tax shelter problems of the 1980s

  2. At-risk Limitations • Tax shelter deductions in total are limited to amount taxpayer is at risk if shelter is a financial disaster and recovery is not possible • Generally, economic investment including any qualified non-recourse financing • Applied before passive activity loss limitations

  3. Examples • Taxpayer invests $50,000 in a partnership in which he is a material participant (not passive). Taxpayer’s share of liabilities assumed are $20,000. • At-risk amount is $70,000. • At-risk amount is increased by taxpayer’s share of income taxed and decreased by taxpayer’s share of loss deducted and withdrawals • Next year, taxpayer has $25,000 share of partnership income and $10,000 in withdrawals • At-risk amount is now $85,000 • Following year, taxpayer has a $100,000 share of partnership loss • Taxpayer may only deduct $85,000 • Remaining $15,000 is suspended

  4. Separate, but Similar Passive Losses • Applies to individuals, estates, trusts, personal service corporations, closely held C corporations • Closely held C’s have more than 50% of outstanding stock owned by five or fewer individuals • Watch for attribution rules • They (only they) may deduct passive losses against active income • No material participation • Material is regular, continuous, and substantial participation • All rental activities, unless excepted • Exceptions include: active participation for $25,000 rental loss exception • Rentals of: bowling shoes, hotel rooms, rehab

  5. Passive Losses • Passive losses in any given year may only offset passive gains (not portfolio or earned income) • Active/Earned income • Portfolio income • Disallowed passive losses are suspended and carried forward until used against future passive gains or until activity is disposed of in-full • In following order: loss on disposed of activity first offsets gain on sale, then passive income, then nonpassive income

  6. Example • Taxpayer, an individual, has $100,000 of passive losses, $75,000 of active income, and $25,000 of portfolio income. How much of the $100,000 can be taken against income? • Taxpayer may deduct $0 • Remaining $100,000 is suspended, to be used against future passive income or disposition

  7. Example • Taxpayer, a closely held C, has $100,000 of passive losses, $75,000 of active income, and $25,000 of portfolio income. How much of the $100,000 can be taken against income? • Taxpayer may deduct $75,000 • Remaining $25,000 is suspended, to be used against future passive income or disposition

  8. 3. During the year, R earned a salary of $100,000 and received interest and dividend income. In addition, his interest in a limited partnership, in which he is a passive investor, produced a loss of $5,000. Which of the following statements is true? a. R can deduct the loss to the extent of his interest and dividend income. b. R can never deduct this loss. c. R cannot deduct the loss but can carry it over and deduct in subse­quent years under the appropri­ate circumstances. d. More than one but less than all of the above statements are true. e. None of the above statements is true.

  9. True or False? • 1. During the year, J sold his interest in Sterling XXI, a limited partner­ship, for a gain of $30,000. At the time of the sale, J had suspended losses from Sterling of $50,000. For the year, J also had a loss from another passive activity of $35,000. As a result, J's taxable income will decrease by $50,000, and he will have a suspended loss of $5,000.

  10. If Multiple Passive Losses • Allocate suspended losses pro rata against the sum of all activities generating passive losses

  11. Credits from Passive Activities • Can only be used against regular income from passive activities • If not usable, are lost when activity is sold

  12. If Passive Converts to Active • Suspended losses are allowed against income from active business

  13. Disposition of Passive Loss Exceptions • If transferred at death, suspended losses allowed in amount exceeding step-up in basis • If transferred by gift, suspended losses added to basis • Installment sales triggers pro-rated recognition of loss • In non-taxable exchange, taxpayer keeps suspended losses, taken no later than when property is sold.

  14. $25,000 Rental Realty Exception • May deduct against active or portfolio income • If taxpayer: • Is an active participant • AGI less than $100,000 (reduced 50% by amount over threshold)

  15. TV TAX- 3’ Company/The Ropers • The Ropers live in one apartment and lease several more • Do they qualify for the Rental Realty Exception?

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