Chapter 6 Flashcards
At risk/passive activity loss limitations
Tax basis hurdle
Limit’s taxpayer’s deductible operating losses to tax basis in business or rental activity. Any losses not deductible are carried forward and are deductible if and when taxpayer sells investment asset such as corporate stock or another similar asset.
How is the tax-basis loss limitation applied?
First determine the taxpayer’s tax basis in the activity. Very generally, this is the taxpayer’s investment in the activity adjusted for certain items (namely income, debt, and investments.)
At-risk rules
Taxpayer considered to be at-risk in an activity to the extent of any cash or the basis of any property personally contributed to activity and certain other adjustments similar to those for tax-basis.
Tax-basis and at-risk
Computations are similar; as a result, the amounts are typically the same. When one clears the tax-basis hurdle, they typically clear the at-risk hurdle as well. If amounts differ, at-risk will be lower. Losses that clear tax-basis but not at-risk are suspended until taxpayer generates more at-risk amounts to absorb loss or activity is sold, when they may offset seller’s disposition of activity.
Material participation test (1-3)
1) Individual participates in activity more than 500 hours during the year.
2) Individual’s activity constitutes substantially all of the participation in such activity by all individuals, including nonowners.
3) Individual participates more than 100 hours during the year, and individual’s participation is not less than any other individual’s participation in the activity.
Material participation test (4-7)
4) Activity qualifies as “significant participation activity” (more than 100 hours spent during the year), and the aggregate of all “significant participation activities” is greater than 500 hours for the year.
5) Materially participated in the activity for any 5 of the last 10 preceding taxable years.
6) Materially participated for any three years in any personal service activity (personal services in health, law, accounting, architecture, etc.)
7) Taking into account all facts and circumstances, individual participates on a regular, continuous and substantial basis during the year.
Passive Activity Income or Loss
Income or loss from an activity in which the taxpayer is not a material participant.
Portfolio income
Income from investments including capital gains and losses, dividends, interests, annuities and royalties.
Active business income
Income from sources in which taxpayer is a material participant. For individuals, this includes salary and self-employment income.
What is done with passive activity income/losses?
Suspended and remain in the passive income or loss category until the taxpayer generates passive income, either from the passive activity producing the loss or from some other passive activity, or until the taxpayer sells the entire activity that generated the passive loss in a taxable transaction.
How are passive losses aggregated on a sale?
Current and suspended losses from the activity are first applied to reduce gain from the sale of the activity, then to reduce net passive income from other passive activities, and then to reduce nonpassive income.
Active participant in a rental activity
Taxpayer who is an active participant in a rental activity may be allowed to deduct up to $25,000 of the rental loss against other types of income. To be considered an active participant:
1) Own at least 10% of the rental property
2) Participate in the process of making management decisions, such as approving new tenants, deciding on rental terms and approving repairs and capital expenditures.
Rental rental loss limit
$25,000; phased out by 50 cents on the dollar for every dollar taxpayer’s AGI exceeds $100,000. $150,000 is the limit.
