Passive Activity and Tax Implications of Special Circumstances

Question 1

Passive activities

Answer 1

• a trade or business in which the taxpayer does not materially participate

Question 2

Passive activity loss

Answer 2

• losses from passive activities may only offset profits from passive activities
• passive loss cannot be used to reduce portfolio income, compensation, or business income
• netting is on Sched. E

Question 3

Different income buckets

Answer 3

active income
- wages
- commissions

portfolio income
- dividends
-interest
- capital gains

passive income
- nonpublic limited partnerships (PAL)
- nonpublic traded partnership (RELP)
- only used to offset passive income generators (PIG)

Question 4

Investment in passive activities

Answer 4

• owning equity interest without rendering services to business (not materially participating)
• limited partner can only deduct loss to extent of income generated by another passive activity

Question 5

Types of passive activity

Answer 5

1. Rentals, including both equipment and rental real estate (except active), and royalty income (oil)
2. Business’ not materially participating
   - limited partnerships
   - partnerships, s corp, limited liability companies not materially participating

Question 6

Publicly traded partnerships (PTP) rules

Answer 6

Aka. Master limited partnerships (MLP)
- portfolio income (dividends) on Sched. B
- publicly traded if the interests are traded on established securities market
- income from PTP may not be sheltered by passive loss from any other source
- losses from PTP cannot offset passive income from other sources
- Net losses from PTP must be carried forward and used only against future income from same partnership or until partnership is sold

Question 7

Treatment of disallowed losses

Answer 7

aka. suspended losses
- carried forward until taxpayer can dispose of the interest
- no 3k cap like capital gains

Question 8

Disposition of passive activities

Answer 8

• limitation of loss deduction is not permanent
• partnership can make income to offset prior year loss
• when investor disposes of entire interest in passive activity in taxable transaction (sale) or dies, any suspended losses are fully deductible in year of disposition

Question 9

Phantom income from limited partnerships

Answer 9

• may occur in tax shelter prior to 1986 Act
• debt that is forgiven
• zero coupons, s corps, k-1 with no cash distribution

Question 10

Material participation

Answer 10

• if taxpayer in involved in the operation of the activity on a regular, continuous, and substantial basis
• no limited partner is treated as materially participating

Question 11

Active participation

Answer 11

• less stringent than material participation
• still passive
• exception to passive loss rules
• bona fide involvement in management decisions
• must own at least 10% interest in the property

Question 12

$25,000 loss from real estate activity

Answer 12

• qualifying taxpayers may deduct up to $25k per year of net losses from real estate activity
• phased out AGI between 100k and 150k on 2-1 basis
• deduction can offset active or portfolio income

Question 13

Rental of the principal residence (not passive activity)

Answer 13

• when taxpayer rents home for fewer than 15 days during taxable year, the rental income is excluded from gross income but no deductions allowed
• days of rental more important than amount

Question 14

Tax treatment of renting a vacation home

Answer 14

• a home is treated as residence in any year in which owners use of the unit for personal purposes exceeds the longer of 14 days or 10% of the period of rental use
• if treated as residence instead of business, expenses may not be deducted as a business expense

Question 15

Low income housing credit

Answer 15

• low income housing programs held as passive activity may generate a deduction-equivalent tax credit up to $25k
• no phaseout
• credit calculation
  1. determine marginal rate
  2. multiply $25k by marginal rate
  3. answer is credit amount

Question 16

Oil and gas working interests

Answer 16

• not passive participation so exempted from PAL rules
• losses from oil and gas working interests where partner (general) is personally liable are deductible against active or portfolio income without limits and without respect to taxpayers AGI
• to qualify as working interest, form of ownership may not limit taxpayers personal liability
• if limited partner, loss is passive loss
• percentage depletion can trigger AMT
• cost depletion not AMT item

Question 17

Equipment leasing

Answer 17

• a closely held C corp that is not a personal service corp may use passive losses to offset active but not portfolio income
• exception not available to S corp

Question 18

Married/ Widowed - Filing Status

Answer 18

• in year spouse dies, widow can file joint
• if widow maintains home for dependent child, qualifies for widower status for 2 years
• after 2 years files single or HOH

Question 19

Dependency exemptions

Answer 19

• no personal and dependent exception deductions
• exception deemed to exist for those claiming dependent deductions (HOH, child care tax credit, education tax credit, etc) but it is $0
• full time student under 24, child under 19

Question 20

Community and noncommunity property

Answer 20

• if separate returns filed by couple in community property state, 1/2 income is reported by each spouse
• income from separate property is separate

Question 21

Divorce - alimony requirements

Answer 21

• divorces in/ after 2019, alimony is no longer deductible and recipient cant declare it as income
• can adopt new rule if before 2019 but both spouses need to agree to change

Question 22

When Alimony is deductible

Answer 22

1. divorce finalized before Dec 31, 2018
2. taxpayers cannot file joint or live together
3. payments made in cash
4. made in benefit of spouse (not child)
5. cannot extend beyond death of recipient

Tests
- noncash items not allowed
- cash to third party allowed if pursuant to divorce (rent, mortgage, tax, tuition)
- payments to maintain property OWNED by PAYOR and used by payee doesnt qualify
- if PAYEE OWNS LI policy on life of payor, the policy payments made by payor will qualify

Question 23

Recapture rules - excess front loading of alimony

Answer 23

• if payor makes excess alimony, special rule applies
• calculation based on amount of payment made during first three years post divorce
• if alimony decreases too fast, it really is a disguised property settlement - result: alimony paid (and deducted) will be recaptured as ordinary income

Calculation
- typically no payment in 3rd year
- add what was paid in first two years
- subtract $37,500
- amount is recapture

Calculation
- 3rd year paid
- multiply 3rd year payment by 2
- add it to $37.500
- amount becomes new constant
- total of first 2 years - new constant= recapture

Question 24

Child support

Answer 24

• child support payments are nontaxable to the payee and nondeductible by payor
• any amount tied to a contingency or occurrence of an event relating to a child is considered child support and not alimony