Loss Limitations Chapter 3 pp National Income Tax Workbook

Transcription

1 Loss Limitations Chapter 3 pp National Income Tax Workbook

2 Ordering of Loss Limitations pp

3 Disallowance of certain expenses & losses p Investment interest 2. Activity not engaged in for profit 3. Personal, living or family expenses 4. Life Insurance premiums paid by owner 5. Related party transactions 6. Entertainment expenses 7. Demolition of a structure 8. Illegal activities 9. Depreciation limits

4 Hobby Loss Rules pp Business-like manner 2. Expertise of taxpayer or advisers 3. Time and effort expended 4. Appreciation of assets 5. Success in other activities 6. History of income and losses 7. Amount of profits, if they are occasional 8. Taxpayer s financial status 9. Elements of personal pleasure

5 Applying Hobby Loss Limits p Amounts allowable as deductions without a business activity (such as mortgage interest, property taxes) 2. Deductions that do not reduce basis; limited to activity s remaining income 3. Deductions that reduce basis (limited to activity s remaining income

6 Vacation Home Expense Limitations p. 74 Three Tiers of Deductions: 1. Allowable itemized deductions (property tax, mortgage interest, etc.) 2. Operating Costs (insurance, repairs, utilities) 3. Deductions that reduce basis (depreciation, additional casualty loss)

7 Expense Ratios p. 74 IRS position all deductions x (# of days of rental at fair value / total days the property is used) Bolton v. Commissioner mortgage interest & property tax expenses x (# of rental days / # of days in the tax year) other deductions x (# of days of rental at fair value / total days the property is used)

8 Example 3.2 BOLTON Formula pp

9 Example 3.2 IRS Formula pp

10 14-Day Rule p. 76 Used for personal purposes for more than the greater of: days; or 2. 10% of the total days it is rented to others at a fair rental price

11 S Corp Stock Basis p Exchange 2. Purchase 3. Gift 4. Compensation 5. Inherited 6. Inherited after 8/20/1996

12 Adjustments to Basis p. 78 S Corporation shareholder basis Loss limited to tax basis Stock basis and debt basis - distributions, deductions & losses + income, gains & contributions Deductibility considered before basis limit

13 S Corp Debt Basis pp Example 3.7 Claire is Sole SH of S Corp Guarantees $100,000 bank loan in 2016 Claire pays $20K in 2017 for S Corp Debt basis increases by $20K in 2017

14 Other Increases to Debt Basis Back-to-Back Loans pp S Corp 1 borrows SH loans S Corp 2 Restructuring Terms of the Loan Related Party/Entity Loans SMLLC S Corp 2 Sole = S Corp 2 member

15 Order of SH Basis Adjustments - Stock pp

16 Order of SH Basis Adjustments - Stock pp

17 Basis Limit for Partners pp Initial basis is same as S Corp rules Loss deduction limited to basis Change in share of liabilities effects: Increase = basis increase Decrease = basis decrease

18 Partners share of Recourse Liabilities pp Partner bears economic risk for pymt Determined by hypothetical liquidation Assets sold for amt of liabilities or zero Net loss allocated to partners Partners must restore negative balance

19 Partnership Recourse Liabilities Example 3.14 pp BOOK VALUE TAX BASIS ASSETS Cash $38,000 $38,000 Equipment (Linda) $44,000 $32,000 Building $400,000 $400,000 TOTAL ASSETS $482,000 $470,000 LIABILITIES & CAPITAL Mortgage $350,000 $350,000 Capital, Barbara $44,000 $44,000 Capital, Joe $44,000 $44,000 Capital, Linda $44,000 $32,000 TOTAL LIAB & CAPITAL $482,000 $470,000

20 Partnership Recourse Liabilities Example 3.14 pp

21 Partnership Recourse Liabilities Example 3.14 pp

22 Adjustments to Partner s Basis p. 84 Increased by: 1. Additional contributions 2. Increased share of PS liabilities 3. Share of taxable/nontaxable income Decreased (not below zero) by: 1. Distributions: $, assets, or liab. decrease 2. Share of PS losses 3. Share of nondeductible expenses

23 Second Base: At Risk Rules pp Applies to individuals, estates, trusts and closely held corporations Amount at risk = money contributed, debt (TP is personally liable) FMV of property superior liens = Amt at risk (TP is not personally liable) Investment interest expense is limited to net investment income

24 Qualified Nonrecourse Financing p. 86 Real estate placed in service after 1986 subject to at-risk Qualified nonrecourse debt = at-risk 1. Borrowed for holding real prop 2. Borrowed from qualified party 3. No person personally liable 4. Not convertible debt

25 Adjustments to At- Risk Amount p. 87 INCREASES Cash or property Income produced Refinancing nonrecourse to recourse loan Gain on disposition DECREASES W/D of cash or property Change in share of losses

26 Third Base: Passive Activity Limits p. 87 Applies to individuals, estates, trusts, personal service corps and closely held corps Must meet one of three criteria: Income from the same activity Income from other passive activities Full disposition of interest to unrelated party

27 Income Baskets p. 88

28 PAL Exceptions p. 88 $25,000 Special Allowance Real Estate Professionals Qualifying dispositions

29 C Corporation Losses p. 89 PAL Limits apply to: Closely Held C Corp Personal Service Corp No $25,000 Special Allowance (PSC)

30 C Corporation Losses p. 89 Closely held C corp deemed to materially participate if: 1 employee actively managed for 12 months, AND 3 full time nonowners work is directly related to the activity, AND Business deductions of the activity > 15% of gross income of the activity

31 PAL Activities p. 90 Passive Activity definition: any rental activity a trade or business in which the taxpayer does not materially participate

32 PAL Exceptions p. 90 Exceptions: Oil and Gas Investments Casualty Losses

33 PAL Carryforward p. 91 Suspended loss/credits carried forward treated as from activity in next year Suspended loss must be allocated: 1. Among loss activities 2. Among losses within each activity 3. Allocate: Loss total losses

34 Passive Activity Credit p. 92 Allowed only to extent of tax on passive income Suspended credits carry over Pass-through credit from passive activity cannot reduce tax on other income

35 Rental Activities p Generally rental activities are passive regardless of participation level Customer use exemptions: Average use not more than 7 days Average use 8 to 30 days Average use more than 30 days

36 Nonrental Activities p. 94 Property available during defined hours for nonexclusive use Lodging rented to an employee for convenience of employer Incidental rental of property Property provided by partner or shareholder

37 $25,000 Special Allowance pp Three Qualifications: 1. T/P is natural person or qualifying estate. 2. Individual actively participates in activity. 3. T/P s income does not exceed limits. MAGI < $100, reduction for each $1 over 100K Phased out at $150,000

38 Income and Loss Offset pp Net all active participation rentals first Example 3.27

39 Tests to qualify as Real Estate Professionals pp > 50% of personal services performed during tax year must be in real property trades or businesses in which the taxpayer materially participates. 2. The taxpayer must perform > 750 hrs of service during the tax year in real property businesses in which he or she materially participates. Only applies to individuals & closely held C corps

40 Participation Recordkeeping p. 97 Good time log is vital; not a ballpark guesstimate Work must be an action that professional normally performs Real estate must be primary job

41 Material Participation p. 97 Passive v. Nonpassive depends on Material Participation Regulations provides 7 tests to meet material participation Exceptions for owners Exceptions for investors

42 Material Participation pp tests for material participation: 1. More than 500 Hours 2. Sole Participant 3. >100 hrs, not less than anyone else 4. Significant Participation, Combined Activities 5. Material Participation for 5 out of 10 Years 6. Personal Service Activity 7. Facts & Circumstances

43 Limited Liability p. 100 Limited partners can use only 500- hour test and prior-year tests LLC members interests are tested under management rights standard If member has management right, all of the 7 tests can be applied

44 Recharacterization of Income pp Significant Participation Passive Activities TP participates >100 hrs but <500 hrs If net result is loss passive If net result is income active Other income recharacterized as nonpassive income from renting nondepreciable property income from passive equity financed lending activity income from rent incident to development Royalty income from pass-through entity Income from rent to related party

45 Self-Charged Interest p. 102 Interest income generally portfolio income Portfolio income cannot be offset by passive activity losses Regs allow TP who lends money to flowthrough entity for a passive activity to recharacterize interest as passive

46 Grouping Activities pp TP must identify the real property businesses in which they are involved TP permitted to group activities. Material participation rules considered after the real property businesses are identified

47 Other Grouping Restrictions pp Election must treat all interests in rental real estate as a single activity Limited partner or limited entrepreneur exceptions Election made by filing a statement with their original income tax return for the tax year

48 Disposition of Passive Activity pp Disposition of entire interest At a loss All losses active At a gain - Absorb Suspended loss, offset from other activities Disposition by Gift Related Party Transactions

49 Disposition of Passive Activity pp Transfer of interest due to death Installment sale of entire interest Activity no longer treated as passive Like kind exchanges

50 Sale of Partial Interest p. 106 Gain recognized may be offset by losses & credits from passive activities Loss recognized is subject to the passive activity loss limits Suspended losses not allowable until disposition of all properties

51 Run Scored: Tax benefit from loss p. 107 No current tax benefit unless the TP has income which can be reduced Negative income from one year may be used as a deduction in another Net operating loss (NOL) may be generated

52 Thank You!