CERTIFIED FINANCIAL PLANNER CERTIFICATION
PROFESSIONAL EDUCATION PROGRAM
Income Tax Planning
Session 10
Passive Activity Loss Rules
©2014, College for Financial Planning, all rights reserved.
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 & trusts
o Closely-held C corporations
o Personal service corporations
10-3
Passive Activities
• Trade or business activity without material
•
participation
(or)
All rental activities except:
o Hotel/motels
o Rental activities with significant services
provided
o Short-term rentals of property
(DVDs, tuxedos, etc.)
o Material participation in real property trades
or businesses
o Active participation in rental real estate
10-4
Material Participation
• Meets one of seven tests under regulations
o 500 hours per year of participation—most
common test
o 100 hours and no one participates more
o 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,
or
o a related person on commercially reasonable terms
10-11
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 to
a. 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 income
b. certificates of deposit generating portfolio income
c. a publicly traded limited partnership generating
income
d. 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:
income from ABC
$10,000
(a publicly traded limited partnership)
loss from DEF
(a publicly traded limited partnership)
income from RST
(a nonpublicly traded limited partnership)
$11,000
$13,000
loss from XYZ
$19,000
(a nonpublicly traded limited partnership)
What is the total amount, if any, of passive losses that may be
deducted during the current year?
a. $0
b. $13,000
c. $23,000
d. $29,000
e. $30,000
10-18
CERTIFIED FINANCIAL PLANNER CERTIFICATION
PROFESSIONAL EDUCATION PROGRAM
Income Tax Planning
Session 10
End of Slides
©2014, College for Financial Planning, all rights reserved.