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:: Passive Activity Loss ATG - Exhibit 5.2: Dispositions Triggering Losses
Exhibit 5.2:
Dispositions
Triggering Losses
ISSUE: Are
current and
suspended passive
losses fully
deductible due to a
disposition? In
other words, is the
transaction an
entire
disposition to an
unrelated party
in a fully
taxable
transaction? If not,
losses remain on
Form 8582 and are
deductible only to
the extent of
passive income.
_____ Verify
that all gains
and losses have been
realized and
recognized. The
following are not
fully taxable:
-
Like-kind
exchanges.
-
Conversion to
personal use.
-
Transfer to a
corporation or
partnership.
-
Transfer due to
divorce (treated
as gift-IRC §
469(j)(6) & §
1041(b).
-
Installment sale
(PALs triggered
in ratio to gain
reported).
-
Bankruptcy (see
below).
NOTE: The
absence of Form 4797
attached to the
return may indicate
that there is not a
fully taxable
disposition.
_____ Verify the
loss has been
deducted in the
correct year.
The Senate Report
indicates that the
taxpayer’s
accumulated tax
loses should be
permitted to be
deducted when, and
only when the actual
economic gain or
loss on the activity
can finally be
determined.
_____ Does the
taxpayer still own
the activity, just
in a different
entity form? An
entity is not an
activity. An
activity is a
business or a rental
activity. The
entity form may
change, i.e. from a
partnership to an
LLC, but the
taxpayer has not
disposed of his
“activity”, i.e.
rental or business
activity.
_____ Did the
taxpayer sell his
partnership/S
Corporation interest
– and then
repurchase it within
a short time?
Substance versus
form governs in tax
law. The Senate
Finance Committee
Report on P.O.
99-514 (1986)
states, “For
example, sham
transactions,
transfers not
properly treated as
sales due to the
existence of a put,
call or similar
right relating to
repurchase do not
give rise to
allowance of
suspended losses.”
_____ If the
taxpayer is in
bankruptcy:
-
A transfer of a
passive activity
to a bankruptcy
estate does not
constitute an
entire
disposition in a
fully taxable
transaction (in
other words,
gain or loss has
not been
recognized).
See IRC §
469(g), IRC §
1398(f)(1), Reg.
§
1.1398-1(d)(1).
-
If bankruptcy is
complete, verify
that tax
attributes have
been reduced by
cancelled debt,
specifically
that current and
suspended losses
have first been
applied against
any mortgage or
other debt
forgiven. In
many instances,
the debt
cancelled under
§ 108 fully
absorbs any
current or
suspended
losses, and
therefore
nothing is
deductible on
the return.
-
Inquire whether
the bankruptcy
estate may have
already used
suspended
passive losses.
Some taxpayers
carry the losses
into subsequent
years, despite
having been used
by the
bankruptcy
estate.
-
Before allowing
losses, consider
basis and
at-risk
limitations.
Furthermore, if
the property is
transferred out
of the
bankruptcy
estate back to
the taxpayer, he
still has an
ownership
interest and
losses are not
triggered by IRC
§ 469(g). Such
a transfer is
not a qualifying
disposition.
_____ Verify that
disposition is not
to a related
party. See
IRC § 469(g)(1)(B),
§ 267, § 707(b). If
passive activity was
sold or otherwise
transferred to a
related party,
losses stay with the
taxpayer. There is
not a triggering
disposition. The
following are
related parties:
Spouse, brothers,
sisters, sons,
daughters,
grandchildren; an
individual and a
corporation owned
more than 50 percent
by the same person;
a partnership and a
partner who owns
more than 50
percent. The IRC §
267(a) disallows
losses for sales or
exchanges to related
parties under IRC
267(b).
Be
sure to look at the
ownership percent on
the Schedule K-1.
Under IRC §
707(b)(1)(A), if a
person, directly or
indirectly, owns
more than 50 percent
of the capital
interest or
the profits interest
of a partnership, he
is a related party.
_____ Verify
that
substantially
all of
the activity
was sold
or
otherwise disposed
of. See IRC §
469(g) & Reg. §
1.469-4(g).
_____ Verify
that
activity has
been truly
terminated
(in other words,
that it is not
continuing on as an
LLC or other entity
or another Schedule
C under a different
name, but the
taxpayer still
retains an ownership
interest). The
Senate Report (S.
Rep. 99-313, 99th
Cong., 2d Sess.)
states, "The
taxpayer must
dispose of his
entire interest in
an activity in order
to trigger the
recognition of
loss. If he
disposes of less
than his entire
interest, then the
issue of ultimate
economic gain or
loss on his
investment in the
activity remains
unresolved. A
disposition of the
taxpayer’s entire
interest involves a
disposition of the
taxpayer's interest
in all entities
that are engaged in
the activity, and
... all assets
used or created in
the activity."
(Emphasis added.)
Note that the Senate
report indicates all
entities and all
assets (used in the
activity and
inventory created by
the activity).
_____ Check Form
8582 to see if Form
4797 gain on
disposition may have
been improperly
entered on line 1a
or 3a. Gain on
disposition belongs
on Form 8582 only
if there is an
overall gain
after considering
current and
suspended losses.
If there is an
overall gain, both
the gain and
the losses should be
on Form 8582. Gain
should never be
reflected on Form
8582 without the
associated losses.
If there is an
overall loss after
current and
suspended losses are
subtracted from net
gain, nothing
(neither gain nor
losses) should be on
Form 8582.
_____ If owner
died, verify that
suspended losses are
allowed only to
the extent they
exceed the amount by
which the
transferee's
basis in
the
passive
activity has
been
increased.
Basis is generally
stepped up to FMV.
If the increase in
basis exceeds unused
passive losses, no
PALs are
deductible.
Neither the deceased
taxpayer nor the
beneficiary will
ever be able to
deduct the losses.
_____ If
disposition was by
gift or charitable
contribution, loss
is not
deductible.
Instead, the basis
of the asset for the
donee is increased
by unused losses.
See IRC § 469(j)(6).
_____ If loss is
from a "rental",
verify that it was
not a temporary
rental of
the taxpayer's
residence.
If the rental period
was less than a year
or two, IRS may view
it as a temporary
rental lacking in
the necessary profit
motive under IRC §
183, i.e. a
nondeductible
loss. Deductions
for rental of a
personal residence
may also be limited
under IRC § 280A.
_____ Verify via
Form 4797 and the
depreciation
schedules that prior
year depreciation
has been properly
recaptured and
treated as
ordinary income.
_____ Consider
whether the
taxpayer is
subject to
AMT.
Depreciation and
other AMT preference
and adjustment items
relating to a
passive activity are
suspended until the
year of a qualifying
disposition (or
there is passive
income to trigger
losses).
Consequently, in the
year of sale or
other disposition,
AMT may result. All
prior and current
year suspended
preference and
adjustment items
should be reflected
on the line on Form
6251, Alternative
Minimum Tax-
Individuals for
passive activities.
LAW: Under IRC
§ 469(g),
current and
carryforward passive
activity losses are
fully deductible in
the year of an
entire disposition
in a fully taxable
transaction to an
unrelated party. A
qualifying
disposition may
create an Net
Operating Loss (NOL)
which can be carried
back. See IRC §
172. NOTE:
Whether or not there
is a qualifying
disposition, passive
losses will always
be triggered up to
passive income
reflected on the
return.
CONCLUSION:
Passive losses in
the amount of $
______ have/have not
been adjusted for
the following
reason: ___________.
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