XM#!X#!!! Page 2 FORM 8582 This presentation represents the opinions and conclusions of the speaker and not necessarily those of any organization or company.
THIS IS A WORKING SEMINAR! YOU ARE INVITED TO PARTICIPATE! Click here for help. I m going to ask questions. And you are welcome to ask questions! THIS STUFF CAN BE COMPLEX!
Page 2 IRC 469(c) TWO TYPES OF PASSIVE ACTIVITIES 1) Business In which TP does not materially participate 2) Rental Real estate & Equipment leasing Passive whether or not TP materially participated!
Page 2 IRC 469(c) WHAT IS PASSIVE ON A K-1? K-1 Box 1 Business if investor did not materially participate K-1 Box 2 Rental real estate K-1 Box 3 Equipment Leasing Other items?
Page 2 IRC 469(a) (2) Individuals Estates Trusts Personal Service Corporations Closely Held C Corps (limited) What s not included??? Partnerships, S Corps, Widely held C Corps PAL limits do not apply to them.
Page 2 IRC 469(d)& (e) IRC 469(b) PASSIVE LOSSES CAN ONLY OFFSET PASSIVE INCOME. UNUSED PASSIVE LOSSES ARE CARRIED FORWARD INDEFINITELY. PASSIVE LOSSES CANNOT BE CARRIED BACK.
Page 2 IRC 469(a)& (d) - Passive Losses Can Offset Only Passive Income + - NO PASSIVE INCOME... NO PASSIVE LOSS!!
Page 2 IRC 469(a)& (d) Passive Losses Not deductible without passive income. Passive Income Additional 3.8% tax! BEST SCENARIO: EVERYTHING NON-PASSIVE!
Page 2 *$25,000 of rental real estate losses FOR RENT! *Rental losses of a real estate professional, if he materially participated in each rental *All current and carryover losses when sold to unrelated party in fully taxable transaction. *Trader in stocks & bonds - K-1 line 1 *Working interests in oil & gas
IRC 469(e) IRC 469(c) Reg. 1.469-1T(e)(6) SO WHAT S NONPASSIVE? Wages, 1099 commissions, guaranteed pmts Business in which TP materially participated Interest, dividend, royalty, gain on stocks & bonds Pension income, IRA, annuities What about on a K-1? Investment interest? Contributions? Page 2
Page 2 & 13 IRC 469(h) MATERIAL PARTICIPATION IRC 469(h) & Reg. 1.469-5T CALENDAR nday Monday Tuesday Wednesday Thursday Friday Saturday 1 2 Regular 4 5 6 7 8 9 11 12 13 14 15 16 18 19 20 21 22 23 25 26 27 28 29 30 CALENDAR nday Monday Tuesday Wednesday Thursday Friday Saturday 1 2 Continuous CALENDAR 4 5 6 7 8 9 nday Monday Tuesday Wednesday Thursday Friday Saturday 1 2 CALENDAR 11 12 13 14 15 16 4 5 6 7 8 9 Monday Tuesday Wednesday nday Thursday Friday Saturday 1 2 18 19 20 21 22 23 11 12 13 14 15 16 4 5 6 7 8 9 and 25 26 27 28 29 30 18 19 20 21 22 23 11 12 13 14 15 16 25 26 27 28 29 30 18 19 20 21 22 23 25 26 27 28 29 30 Substantial Participation in operations
Page 5 & 13 Businesses Farms K-1 line 1 P-ship or S Corp business Rental real estate owned by real estate professionals Most vacation rentals Hotel, motels, B&Bs
MATERIAL PARTICIPATION Reg. 1.469-5T, Page 13 If materially participating, losses allowed in full. If not, losses go on Form 8582. No losses deductible without passive income. 7 tests in Reg.1.469-5t(a) Most common = 500 hours for the year.
IRC 469(c) (2)&(4) RENTALS ARE PASSIVE EVEN IF TP MATERIALLY PARTICIPATES! *Equipment leases *Rental real estate (but gets $25,000 offset if TP active) Exceptions to rental definition (treated as business): -Average customer use is 7days or less -Average use is 30 days or less & significant services -Extraordinary personal services
MISCELLANEOUS ITEMS LOW INCOME HOUSING CREDITS LP can take credit, but limited to tax equivalent of $25,000 LIH losses if LP, no $25,000 offset NO BASIS IN PARTNERSHIP OR S CORP Loss doesn t go on Form 8582 INTEREST EXPENSE TO BUY PASSIVE 1065/1120S Not investment interest. It s passive activity interest-goes on Form 8582. Deductible only up to passive income! Notice 89-35
AVOID PASSIVE LOSS LIMITS? TRIGGER DEDUCTIBILITY OF PALS?! Group businesses or rentals as ONE activity Reg. 1.469-4 Related businesses or rentals form a single activity. Passive income generator (PIG) Problem: Many passive activities have losses, not income! Sell a rental property Reasons: 1. Recapture of depreciation is passive income! 2. All losses deductible on qualifying disposition. 3. Net gain is passive income-triggers other passive losses! Die! But step-up in basis absorbs passive losses.
TOP 5 PASSIVE LOSS ISSUES Farm loss. TP lives out-of-state. c Rental real estate losses. Real estate professional. Loss from equipment leasing. 1065/1120S loss - Sch E nonpassive column. Losses are not deductible without passive income. Go on Form 8582 line 1b or 3b.
TOP 4 PASSIVE INCOME ISSUES Rental income from a building leased to TP s 1120/1065 is improperly on Form 8582 line 1a as passive income. Income from leased land is on Form 8582. Royalties are on Form 8582. Gain on sale of land held for investment is on F8582. None of this income belongs on F8582, line 1a or 3a, triggering otherwise nondeductible passive losses!
IRS AUDIT! Ask: what are the issues? What triggered exam? Strategize. Game plan beforehand! Disclose any grouping upfront! Reg. 1.469-4 Initial interview. Consider whether there is passive income. Material participation issue 1. Grouped entities/activities 2. Significant participation activities 3. Documentation services & hours! Calendar. Timely response to IRS letters and doc requests Not more than 2 requests for additional time.
HERE S SOME SITUATIONS YOU MIGHT ENCOUNTER? HOW WOULD YOU RESPOND?...
1 IRS Notice: TP owes additional tax. Deducted rental loss when AGI >$150,000. Your response? Yep. You owe it. Pay the tax??? Disposition of property in the year or next? Passive income from another source? Rental related to a business? Grouped? Short-term rental? If so, it s a business. Material participation? Page 2
2 TP bought land. Just holding property. 1 Subject to PAL limitations? 2 Gain on sale passive income? 3 Where does interest expense go? 4 Expenses for maintenance deductible? No to first 2 questions. Not passive activity. Interest expense is investment interest. Maintenance: Misc itemized deduction 2% floor If rented: related to a business? Grouped? Leased land. Rental losses are passive Net income recharacterized as non-passive.
4 New client. 1120S loss on Form 8582, but no basis. Can he deduct losses if there s passive income from another source? Loss should be removed from Form 8582. Not a passive activity until basis. Not deductible even if passive income from another source. Page 2
5 Oil and gas joint venture. No K-1. Just paper with income & expenses. Net loss includes dry hole expenses & intangible drilling costs. TP: I do nothing. Losses deductible? Probably yes! If liability not limited, escapes PAL limits. Joint venture does not limit liability. Even if language in prospectus limits liability, entity doesn t and loss not limited. Income & expenses go on Sch. C. Limit liability: LLC, LP, 1120s.
QUESTIONS???