The American College: HS 321 Income Taxation Chapter 12 Passive Activity Loss Rules.

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Presentation transcript:

The American College: HS 321 Income Taxation Chapter 12 Passive Activity Loss Rules

Chapter 12 Overview Learning Objective Explain the limitations on passive activity losses and credits through understanding of the….. Learning Objective Explain the limitations on passive activity losses and credits through understanding of the….. 1. Abuse prompting the need for legislation. 2. Classification system for various types of income: portfolio, active, & passive.

Chapter 12 Overview - Continued 3. Implications for “rental activities” 4. Operation of the active participation exception for taxpayers at qualifying levels of AGI.

Chapter 12: “Passive” Activities Definition of “passive activity” turns on the term “material participation.” Definition of “passive activity” turns on the term “material participation.” Rental activities are “passive” regardless of participation unless taxpayer is a dealer or full-time property manager. Rental activities are “passive” regardless of participation unless taxpayer is a dealer or full-time property manager.

Chapter 12: “Passive” Activities Deductible passive-activity losses generally limited to taxpayer’s passive activity income. Deductible passive-activity losses generally limited to taxpayer’s passive activity income.

General Features of Section 469 Passive Activities Section 469 applies to individuals, estates, trusts, personal service corps., and closely held “C” corporations. “Portfolio” Investment Income/Loss “Active” Business Income/Loss “Passive” Lacks “Material Part” Classify All Business Activity Into Three Types ABC

General Features of Section 469 Basic Tax Aspects Losses from passive activities cannot be deducted from active or portfolio income. Losses from passive activities cannot be deducted from active or portfolio income. Unlimited carryovers of disallowed losses. Unlimited carryovers of disallowed losses.

Applying Section 469 If the sum of all passive activity = net loss, then apply passive-activity rules. If the sum of all passive activity = net loss, then apply passive-activity rules. If the sum of all passive activity = net gain, then the passive-activity rules don’t apply that year. If the sum of all passive activity = net gain, then the passive-activity rules don’t apply that year. Unlimited carryover of disallowed losses. Unlimited carryover of disallowed losses.

Exceptions to the Passive Activity Rules

Exception to Passive Activity Rules (Rental Activities) When is a rental activity not deemed “passive”? When is a rental activity not deemed “passive”? Unlimited losses from the rental can be deducted if the TP meets 2 tests: Unlimited losses from the rental can be deducted if the TP meets 2 tests: More than 50% of all personal services during the year must be for real property trade or business, and More than 50% of all personal services during the year must be for real property trade or business, and The TP performs more than 750 hours in real property trades or businesses. The TP performs more than 750 hours in real property trades or businesses.

Exception to Passive Activity Rules Individual TPs who “actively participate” in passive rental real estate businesses may deduct up to $25,000 in losses per year from nonpassive income. Individual TPs who “actively participate” in passive rental real estate businesses may deduct up to $25,000 in losses per year from nonpassive income. This $25,000 allowance is reduced by 50% of the individual’s AGI in excess of $100,000 of nonpassive income. This $25,000 allowance is reduced by 50% of the individual’s AGI in excess of $100,000 of nonpassive income.

“Active Participation” in Passive-Rental Activities TP must have at least 10% ownership interest (in the value of the property). TP must have at least 10% ownership interest (in the value of the property). TP must have “significant and bona fide” involvement. TP must have “significant and bona fide” involvement.

End of Chapter 12