104-9 Passive Activity Rules Flashcards
Tax-shelter investments
Intended to defer or eliminate taxes for the investor and, sometimes, generate tax losses considerably in excess of taxpayer income
At-risk rules
Applied before the limits of the passive activity loss rules
Defined as the max deductible loss for an investment limited to the amount that the taxpayer-investor has at risk at the end of the current year
The amount of capital the taxpayer-investor has at risk is:
A) the total of the cash or property invested in the activity; and
B) any debt/borrowings by the activity for which the investor is personally liable (recourse debt)
2 kinds of passive activities
1) Any trade or business in which the taxpayer does not materially participate.
2) Any rental activity, regardless of the level of taxpayer activity.
Suspended loss
A tax loss disallowed because of the at-risk rules is a suspended loss until either the first year in which the at-risk amount is sufficient to absorb the loss or the investment is subsequently sold
Passive Activity Loss Rules
State that passive losses may only be deducted against passive income
Investors are prohibited from deducting passive losses against either active income (wages, salaries, and other employee compensation) or portfolio income (dividends, interest, and capital gains)
An oil and gas activity that involves a working (not royalty) interest in any oil and gas property a taxpayer owns directly or through a general partnership is not a passive activity
Closely-held C Corporations offsetting passive losses rules
Closely-held C Corporations may offset passive losses against active income but not against portfolio income
Material Participation
If the answer to any of the following is yes, the taxpayer is a material participant, and the activity is not classified as passive:
- Does the taxpayer complete more than 500 hrs of participation during the year?
- Does the individual’s participation in the activity constitute substantially all of the participation in the activity of all individuals who participate int he activity (including individuals who are not owners) for the year?
- Does the taxpayer participate for more than 100 hrs, and is this amount equal to or more than any other participant in the activity?
- Is the activity a significant participation activity?
- Did the taxpayer materially participate int he activity in at least 5 of the last 10 years?
- Is the activity a personal service activity, and did the taxpayer materially participate in the activity in any of the 3 previous yrs?
- Using the existing facts and circumstances, did the taxpayer participate on a regular, continuous, and substantial basis during the year?
2 Types of limited partnerships
1) Publicly traded partnership (PTP) aka master limited partnership (MLP)
2) Non-publicly traded or privately offered limited partnership
Publicly traded partnership (PTP) aka master limited partnership (MLP)
Partnership traded on an established securities exchange
Losses from such a partnership
- cannot be used to offset income from a non-publicly traded partnership
- cannot be used to offset income from other publicly traded partnerships
Losses from an MLP that are disallowed may be carried forward and allowed as a deduction in a year when the same MLP has net income or the taxpayer’s interest in the MLP is sold
Non-publicly traded limited partnership [which are typically real estate limited partnerships (RELPs)]
May only be used to offset income from another non-publicly traded limited partnership
This income does not have to be generated from the same non-publicly traded limited partnership
Rental real estate activities
Losses are not considered passive for a real estate professional, provided that real estate activities are more than 50% of her personal services for the year and she puts in more than 750 hrs of work int he real estate activity
The 2nd (and more common) exception is for those small investors who dabble in real estate rental activities In meeting several tests, such investors may deduct up to $25k of rental real estate losses against activity and portfolio income in any 1 year
Disposition of passive activities/suspended losses and carryovers
When a taxpayer disposes of his entire interest in a fully taxable transaction to an unrelated purchaser (not a related party), his suspended losses from that activity, including any losses incurred in the year of disposition, are generally deductible in full
Rental real estate loss allowance for taxpayers who file as MFS
The rental real estate loss allowance is not available to taxpayers who file as MFS and have lived together at any time during the tax year.
If the married persons file separately yet live apart for the entire tax year, the special allowance is $12,500, subject to an AGI phaseout threshold that begins at $50,000. The applicable allowance of $12,500 is reduced by 50% of the amount of the taxpayer’s modified AGI that exceeds the $50,000 threshold amount.
The passive activity loss rules apply to the following taxpayers:
- Individuals
- Estates
- Trusts
- Personal service corporations (PSCs)
- Closely held C corporations (however, note that closely held C corporations may offset passive losses against active income but not against portfolio income)
An oil and gas activity that involves a working (not royalty) interest in any oil and gas property that a taxpayer owns directly or through a general partnership is not a passive activity.
Passive income
income or loss from “any trade, business, or income-producing activity in which the taxpayer does not materially participate” or “any rental activity, whether the taxpayer materially participates or not.
