Passive Activity Flashcards
amount at-risk
amount of adjusted basis in a business that an owner has at a particular point in time:
-increased by contributions, pass-through of income, and certain debt obligations
-decreased by distributions, pass-through of losses, and certain debt repaid by the business entity
Definition of passive activity
Identification of an Activity
Material Participation
Limited Partnerships
Working Interests
Appropriate economic unit factors for identifying separate activities
-Similarities and differences in the types of business
-The extent of common control
-The extent of common ownership
-The geographical location, and
-Any interdependencies between the operations (that is, the extent to which they purchase or sell goods between the activities, have the same customers, or are accounted for with a single set of books).
( any reasonable method of applying the relevant facts and circumstances in grouping the activities.)
Material participation test
->500 hours/yr
->100 hours during the year, and most of any participant
- substantially all of the participation in the activity by all individuals, including individuals who do not own any interest in the activity
-any non-consecutive five years during the immediately preceding ten taxable years.
-any three years preceding the year in question, and the activity is a personal service activity.
-regular, continuous, and substantial basis during the year.
Limited Partnerships
A limited partner has limited liability for his or her investment in the partnership only if the partner has no active involvement. passive in the activities of a limited partnership, as they do not meet the material participation test. Income and deductions from limited partnerships are also considered passive.
Working Interests
Not passive: interest that is responsible for the cost of the development or operation of the oil and gas property (exception to passive activity rules)
Taxpayers Subject to Passive Loss Rules
-Individuals, estates, and trusts
-Any closely held C corporation
-Any personal service corporation
-Certain publicly traded partnerships
Closely Held C Corporations
C corporation where 5 or fewer individuals own >50% of the stock at any time during the last half of the corporation’s taxable year. Passive losses may offset income from active business operations
Personal Service Corporation
C corporation whose principal activity is the performance of personal services that are substantially performed by owner-employees and owns >10% stock value
If corporation is closely held C corporation and PSC, passive losses of a PSC may not offset the PSC’s active business income or portfolio income
Material Participation by PSCs and C Corporations
If one or more shareholders who own more than 50% in value of the outstanding stock materially participate in the activity.
-substantial portion of the services of at least one full-time employee is in the active management of the activity.
-substantial portion of the services of at least 3 full-time non-owner employees is directly related to the activity.
-Section 162 business deductions of the activity exceed 15% of the activity’s gross income for the period.
Publicly Traded Partnerships
partnership where interest in the partnership is either traded on an established securities market or readily available for trading on a secondary market, treated for tax purposes as corporation=> no passive loss rules; however if PTP meets gross income requirements, then income, loss an credit may flow through to partners. Losses treated separate from other types of income that is passive, active, business or portfolio, and income from other PTPs.
Loss is not recognized in the year that the PTP has a passive activity. Suspended losses from PTPS may be deducted in the year the partner disposes interest.
Joe Jones has the following passive activity for the current year:
($5,000) loss from ABC, a publicly traded partnership
$7,000 income from DEF, a publicly traded partnership
($10,000) loss from CHI, a private interest in a limited partnership
$8,000 income from Solar Winds, a private interest in an S-Corporation
How much of the losses will be suspended and carried over?
$7,000 of losses must be suspended [($5,000) from ABC & ($2,000) from CHI].
Three categories of taxpayer’s income
- active income (wages, active business income)
- portfolio (investment)- part of net investment income, which is used in deduction limit for interest expense
-passive
Suspended losses
passive activity losses that are disallowed as deductions for the year incurred are carried over and may offset passive activity income of the subsequent year, but not other types
taxable disposition of interest
When passive activity is disposed of in a taxable transaction, suspended losses may be deducted against other income; however the amount of total net economic loss from disposed asset must offset any passive income from other passive activities.
suspended losses of a passive activity become deductible only when the taxpayer completely disposes of his or her interest in the activity. In the case of a death, the amount of the deduction allowed is the amount suspended losses exceed increase in the basis of the property