1.5 - Loss Limitations For Individuals Flashcards
What are the four limitations on the deduction of business and rental activity losses? And what do each apply to?
Tax basis limitation - flow thru entities (K-1)
At-risk limitation - flow thru entities (K-1)
Passive activity loss limitation - rental real estate
Excess business loss limitation - maximum $ amount allowed is limited
What is the investment in the ownership interest, adjusted for item such as income, deductions, distributions, and, in some cases, debt?
Tax basis
What are the tax basis limitations for flow thru entities?
A loss can only be flowed through to the owner’s individual income tax return and deducted to the extent of the owner’s tax basis. A loss in excess of the owner’s tax basis is suspended until tax basis is reinstated in future years and is carried forward indefinitely.
What are the At-Risk limitations for flow thru entities?
A loss can only be flowed thru to the owners individual income tax return and deducted to the extent that the owner is “at risk”. The amount a taxpayer is “at risk” represents the taxpayer’s economic risk in the activity. A loss in excess of the owner’s at-risk basis is suspended until at-ris basis is reinstated in future years and is carried forward indefinitely.
What happens to losses that clear the tax basis and at-risk hurdles ?
They are flowed thru to the owner’s individual income tax return
Under the passive activity loss limitation, al income and loss items are sorted into three categories or “baskets”:
Active
Passive
Portfolio
What is included in the active category under the passive activity loss limitation?
Salaries and wages
Guaranteed payments for services
Business income or loss from activities which the tax payer actively participates
What is included in the passive category under the passive activity loss limitation?
Business income or loss from activities in which the taxpayer dos not materially participate
Rental real estate in automatically considered passive unless exception applies
Income or loss from a limited partnership interest is automatically considered passive
What is included in the portfolio category under the passive activity loss limitation?
Interest
Dividends
Annuities
Royalties
Capital gains and losses
A taxpayer is considered to b a material participant if:
They are involved in the operations of the activity on a regular continuous basis for more than 500 hours during the tax year
How do taxpayers deduct for passive activity loss?
PAL can only be offset against passive activity income. A net PAL for the year is suspended and carried forward indefinitely to offset future passive activity income. A net PAL is allowed when sold.
There are two exceptions to the passive activity loss limitation. What are they?
Mom and pop exception
Real estate professional exception
What is the mom and pop exception to the passive activity loss limitation?
Taxpayer may deduct up to $25,000 of net PAL per year if the taxpayer:
- actively participates in the rental real estate activity
- ownes at least 10% of the rental real estate activity
The 25K allowance is reduced by 50% of the excess of the taxpayer’s AGI over 100K. It is eliminated when AGI exceeds 150K.
What is the real estate professional exception to the passive activity loss limitation?
If a taxpayer is a real estate professional, rental real estate activities are considered to be active rather than passive and the PAL limitation does not apply.
Are taxpayers allowed to deduct an overall excess business loss for the year?
No
