Passive Activity

Question 1

amount at-risk

Answer 1

amount of adjusted basis in a business that an owner has at a particular point in time:
-increased by contributions, pass-through of income, and certain debt obligations
-decreased by distributions, pass-through of losses, and certain debt repaid by the business entity

Question 2

Definition of passive activity

Answer 2

Identification of an Activity
Material Participation
Limited Partnerships
Working Interests

Question 3

Appropriate economic unit factors for identifying separate activities

Answer 3

-Similarities and differences in the types of business
-The extent of common control
-The extent of common ownership
-The geographical location, and
-Any interdependencies between the operations (that is, the extent to which they purchase or sell goods between the activities, have the same customers, or are accounted for with a single set of books).
( any reasonable method of applying the relevant facts and circumstances in grouping the activities.)

Question 4

Material participation test

Answer 4

->500 hours/yr
->100 hours during the year, and most of any participant
- substantially all of the participation in the activity by all individuals, including individuals who do not own any interest in the activity
-any non-consecutive five years during the immediately preceding ten taxable years.
-any three years preceding the year in question, and the activity is a personal service activity.
-regular, continuous, and substantial basis during the year.

Question 5

Limited Partnerships

Answer 5

A limited partner has limited liability for his or her investment in the partnership only if the partner has no active involvement. passive in the activities of a limited partnership, as they do not meet the material participation test. Income and deductions from limited partnerships are also considered passive.

Question 6

Working Interests

Answer 6

Not passive: interest that is responsible for the cost of the development or operation of the oil and gas property (exception to passive activity rules)

Question 7

Taxpayers Subject to Passive Loss Rules

Answer 7

-Individuals, estates, and trusts
-Any closely held C corporation
-Any personal service corporation
-Certain publicly traded partnerships

Question 8

Closely Held C Corporations

Answer 8

C corporation where 5 or fewer individuals own >50% of the stock at any time during the last half of the corporation’s taxable year. Passive losses may offset income from active business operations

Question 9

Personal Service Corporation

Answer 9

C corporation whose principal activity is the performance of personal services that are substantially performed by owner-employees and owns >10% stock value

If corporation is closely held C corporation and PSC, passive losses of a PSC may not offset the PSC’s active business income or portfolio income

Question 10

Material Participation by PSCs and C Corporations

Answer 10

If one or more shareholders who own more than 50% in value of the outstanding stock materially participate in the activity.

-substantial portion of the services of at least one full-time employee is in the active management of the activity.
-substantial portion of the services of at least 3 full-time non-owner employees is directly related to the activity.
-Section 162 business deductions of the activity exceed 15% of the activity’s gross income for the period.

Question 11

Publicly Traded Partnerships

Answer 11

partnership where interest in the partnership is either traded on an established securities market or readily available for trading on a secondary market, treated for tax purposes as corporation=> no passive loss rules; however if PTP meets gross income requirements, then income, loss an credit may flow through to partners. Losses treated separate from other types of income that is passive, active, business or portfolio, and income from other PTPs.
Loss is not recognized in the year that the PTP has a passive activity. Suspended losses from PTPS may be deducted in the year the partner disposes interest.

Question 12

Joe Jones has the following passive activity for the current year:

($5,000) loss from ABC, a publicly traded partnership
$7,000 income from DEF, a publicly traded partnership
($10,000) loss from CHI, a private interest in a limited partnership
$8,000 income from Solar Winds, a private interest in an S-Corporation
How much of the losses will be suspended and carried over?

Answer 12

$7,000 of losses must be suspended [($5,000) from ABC & ($2,000) from CHI].

Question 13

Three categories of taxpayer’s income

Answer 13

• active income (wages, active business income)
• portfolio (investment)- part of net investment income, which is used in deduction limit for interest expense
  -passive

Question 14

Suspended losses

Answer 14

passive activity losses that are disallowed as deductions for the year incurred are carried over and may offset passive activity income of the subsequent year, but not other types

Question 15

taxable disposition of interest

Answer 15

When passive activity is disposed of in a taxable transaction, suspended losses may be deducted against other income; however the amount of total net economic loss from disposed asset must offset any passive income from other passive activities.

suspended losses of a passive activity become deductible only when the taxpayer completely disposes of his or her interest in the activity. In the case of a death, the amount of the deduction allowed is the amount suspended losses exceed increase in the basis of the property

Question 16

Carryovers from a Former Passive Activity

Answer 16

are deductible against active business income. Any loss carryover from a former passive activity is deductible against the current year’s income of that activity

Question 17

Requirements to qualify for Exception to Rental Activities as Passive

Answer 17

->one third of personal services must be in real property trades/business in which the taxpayer participates
-and perform >750 hours of work in real property trades/business
For closely held C Corporation, must derive ?half its gross receipts from real property businesses

Question 18

Requirements for an individual to be able to deduct up to $25,000 annual losses from passive rental real estate activities against other income

Answer 18

Actively participate in activity and own at least 10% of value of activity for entire tax year

Question 19

Active participation

Answer 19

must participate in the making of management decisions or arranging for others to provide services in a significant and bona fide sense. This includes approving new tenants, deciding on rental terms, approving expenditures, and other similar decisions.

Question 20

Rehabilitation, Revitalization, and Low Income Housing Credits

Answer 20

Up to $25,000 deduction, even if the taxpayer does not actively participate

Question 21

Limitation on deduction

Answer 21

After applying rental real estate losses for active participation against other net passive income, may deduct against portfolio or active business income up to $25,000 (reduced by half of AGI in excess of $100,000). If AGI>=150,000, all real estate losses must be suspended and carried over with the taxpayer’s other passive losses.

For historic rehabilitation credits, the phase-out begins at $200,000 of AGI rather than $100,000. Therefore, the taxpayer loses the benefit of the deduction completely if his or her AGI exceeds $250,000.

There is no phase-out for business revitalization or low-income housing credits.

Question 22

Mixed use properties

Answer 22

• personal use: rented <=14 days (no need report income)
• rental use property: personal use no more than greater of 14 days or 10% of number of days rented at FMV
• Mixed use: personal use >14 days/10% of number of days rented at Fair rental value. Deductions are limited to gross rental income and unused losses are carried forward

Question 23

The passive loss limitation rules apply to:

Answer 23

Individuals, estates, and trusts
Any personal service corporation
Any closely held C corporation
Certain publicly traded partnerships

NOT to partnerships and S corporations, as income and losses are taxed directly to shareholders and partners, nor to regular C Corps

Question 24

One of the exceptions to the passive loss rules is _______________________.

Answer 24

working interest in an oil or gas property. A working interest is an interest that is responsible for the cost of the development or operation of the oil and gas property

Question 25

Identify the categories of income according to IRC Section 469.

Answer 25

IRC Section 469 requires taxpayers to classify their income into three categories:

active income (e.g., wages, salaries, and active business income),
portfolio (i.e., investment) income, and
passive income.

Question 26

Joshua is a 40% owner of a rental real estate property and is several management tasks. His MAGI in 2023 is $175,000. This year, the property generated $20,000 in losses. How much of the real estate losses may be claimed in the current year?

Answer 26

Joshua owns at least 10% of the property (40% ownership) and is involved in the overall management. Therefore, he is considered an ‘active participant’ and is eligible to deduct up to $25,000 of real estate losses.

However, Joshua’s MAGI of $175,000 falls outside the phaseout range of $100,000 to $150,000. As a result, $0 of the $20,000 in losses can be claimed in the current year.

Question 27

Sylvia invested $50,000 into a partnership that flips colonial homes in Upstate New York. Of the total losses to the partnership of $100,000 this year, she was allocated $15,000.

Calculate Sylvia’s current amount at-risk.

Answer 27

When a taxpayer has an amount at-risk of $50,000 prior to the current year’s pass-through loss of $15,000, the $15,000 loss will be allowed and the taxpayer’s amount at-risk is therefore reduced to $35,000.

Remember that the at-risk rules are always applied before the passive activity rules.