©2015, College for Financial Planning, all rights reserved.

Session 10Passive Activity Loss Rules

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMIncome Tax Planning

Session Details

Module 5

Chapter 2

LOs 5-4 Identify rules, deductions, or benefits related to a direct participation program.

5-5 Identify requirements that must be met to qualify for a special tax benefit available from a direct participation program.

5-6 Evaluate a situation to select the most appropriate direct participation program, if any.

5-7 Analyze a situation to calculate the allowable deductions under the passive activity loss rules.

10-2

Passive Activity loss rules

• Why?• General Rule—Passive losses deductible

against passive income (except PTPs)• Applies to—

o Individuals, estates, and trustso Closely held C corporationso Personal service corporations

10-3

Passive Activities

• Trade or business activity without material participation (or)

• All rental activities except:o Hotel/motelso Rental activities with significant

services providedo Short-term rentals of property

(DVDs, tuxedos, etc.)o Material participation in real property

trades or businesseso Active participation in rental real estate

10-4

Material Participation

• Meets one of seven tests under regulationso 500 hours per year of participation—

most common testo 100 hours and no one participates

moreo Facts and circumstances test• Regular, continuous, and substantial

involvement• What is taxpayer’s knowledge, background,

experience?

10-5

PAL Exceptions/Opportunities

Active Participation in Rental Real Estate

• Requires “bona fide” involvement• $25,000 of losses allowed annually• $100,000 to $150,000 AGI phaseout of

losses• 10% or greater ownership interest in the

activity• Not a limited partnership interest• Not available if MFS, unless lived apart

for entire year 10-6

PAL Exceptions/Opportunities

Historic Rehabilitation Programs• $25,000 deduction-equivalent tax credit • May offset tax due on up to $25,000 of

other income• $200,000 to $250,000 AGI phaseout

10-7

PAL Exceptions/Opportunities

Low-Income Housing Activity• $25,000 deduction-equivalent tax credit• May offset tax due on up to $25,000 of

other income• $200,000 to $250,000 AGI phaseout if

property placed in service prior to 1990• No AGI limit if property placed in service

after 1989

10-8

Material Participation in Real Estate

Losses deductible if• more than 50% of hours are devoted to

real property trades or businesses with material participation

• more than 750 hours are in real property trades or businesses with material participation

10-9

Oil & Gas Working Interest

Ownership of Oil and Gas Working Interest

• Losses are deemed to be not passive

• The form of ownership cannot limit taxpayer’s personal liability

• No participation is required

• Losses are deductible without limit and without respect to taxpayer’s AGI

10-10

Requirements to Qualify for Special Tax Benefits

Closely Held C Corporation• If not a personal service corporation, passive

losses may be used to offset active income, but not portfolio income.

Qualified Nonrecourse Financing• secured by the real property

• no one is personally liable

• not convertible into equity

• provided either by:o an unrelated entity in the business of lending

money oro a related person on commercially reasonable

terms10-11

Publicly Traded Partnerships• Losses are not deductible

against other passive income.

• Losses are held in suspense until SAME activity generates income.

• Income cannot be offset by passive losses arising from any other source.

10-12

Disposition Rules

Sale/Exchange• All losses are “freed up” and deductible in

full against other income if disposition of “substantially all.”

Death• Losses are deductible to the extent

that the losses exceed step-up in basis of activity.

Gift• Losses are added to basis of

gifted activity.10-13

Review Question 1

The passive activity loss rules apply toa. personal service corporations only.b. closely held C corporations only.c. individuals only.d. personal service corporations, closely

held C corporations, and individuals.

10-14

Review Question 2

Which one of the following is a characteristic of the historic rehabilitation tax credit?a. The credit may be used to offset up to

$25,000 in income tax.b. The credit may be used to offset the tax

on up to $25,000 in income.c. The credit is phased out on adjusted gross

income between $100,000 and $150,000.d. The credit is phased out on taxable

income between $200,000 and $250,000.

10-15

Review Question 3

Your client, Marian Powers, has substantial unused passive losses from a nonpublicly traded limited partnership. She would like to find an investment that would allow her to utilize her passive losses.Which one of the following is the most appropriate investment for Marian?a. a master limited partnership generating incomeb. certificates of deposit generating portfolio incomec. a publicly traded limited partnership generating

incomed. a nonpublicly traded partnership generating

income, in which Marian will not materially participate

10-16

Review Question 4

Sally Franklin has AGI of $300,000. In addition, she currently has passive income of $150,000 and passive losses of $175,000; $150,000 of which she uses to offset the passive income and $25,000 of which is subject to disallowance.

Which one of the following activities, if any, has the greatest potential for reducing Sally’s tax liability?

a. investing in “active participation” rental real estate that is producing a loss

b. investing in a low income housing activity placed in service after 1989 that is producing deduction-equivalent credits

c. investing in a limited partnership involved in a historic rehabilitation project that is producing passive losses and credits

d. investing in an oil and gas limited partnership that is generating losses

10-17

Review Question 5

Paul Hall has the following items from the current year:

What is the total amount, if any, of passive losses that may be deducted during the current year?

a. $0b. $13,000c. $23,000d. $29,000e. $30,000

10-18

income from ABC (a publicly traded limited partnership)

$10,000

loss from DEF (a publicly traded limited partnership)

$11,000

income from RST (a nonpublicly traded limited partnership)

$13,000

loss from XYZ (a nonpublicly traded limited partnership)

$19,000

©2015, College for Financial Planning, all rights reserved.

Session 10End of Slides

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMIncome Tax Planning