Chapter 13
At-Risk/Passive
Activity Loss Rules
and The Individual
Alternative
Minimum Tax
“Never let the tax tail wag the
economic dog.”
Laura Peebles
McGraw-Hill/Irwin
©The McGraw-Hill Companies, Inc. 2008
LO #1- At-Risk Rules
• At-risk activities include any
“engaged…in carrying on a trade of
business or for the production of
income.”
• Initial amount at-risk is any contribution
of money plus the adjusted basis of
contributed property.
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LO #1- At-Risk Rules
• What is “at-risk” or increases “atrisk”
– Cash and property contributions
– Share of liabilities
– Income and gain items
• What decreases “at-risk?”
– Cash and property distributions
– Release of liabilities
13-3
LO #1- At-Risk Rules
• Form 6198 is filed for each activity
subject to the at-risk limitation
• Liabilities that affect at-risk amount
– Recourse debt
– Nonrecourse debt
– Qualified nonrecourse debt
13-4
LO #1- At-Risk Rules
• Losses disallowed under the at-risk
rules
– Carried over indefinitely
– Deducted in years when the at-risk amount
increases
• Losses may still be subject to the
passive loss limitations
13-5
LO #1- At Risk Rules
Concept Check
1. Which of the following items will increase a taxpayer’s at-risk amount?
a. A cash contribution made by the taxpayer into the activity.
b. The taxpayer share of income from the activity.
c. The taxpayer’s share of the activity’s liabilities for which the taxpayer is
personally liable.
d. All of the above.
Answer: D
2. Which of the following type of liability does not increase the taxpayer’s atrisk in an activity?
a. Non-recourse debt.
b. Recourse debt.
c. Qualified non-recourse debt.
d. All of the above increase at risk.
Answer: A
13-6
LO #1- At Risk Rules
Concept Check
3. Which of the following is true when a loss is disallowed by the atrisk rules?
a. The loss is lost forever.
b. The loss can be used only at the activity’s disposal.
c. The loss is indefinitely carried forward.
d. The loss can be used only if the taxpayer makes a
contribution to the activity.
Answer: C
13-7
LO #2 – Passive Activities
• What is a Passive Activity?
– Taxpayer does not materially participate on
a
• Regular
• Continuous
• Substantial basis
• Most rental activities and limited
partnerships are passive by definition
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LO #2 – Passive Activities
• Seven tests for material participation
–
–
–
–
> 500 hours
All of the participation in the activity
> 100 hours and not less than any other person
> 100 hours and several activities that in aggregate
exceed 500 hours
– Material participant for any of the last five years
– Material participant for any of last three years for
personal service activity
– Facts and circumstances
13-9
LO #2 – Passive Activities
• Passive Losses – General Rule
– Passive losses are allowed only to the extent of
passive income
• Income/loss items separated into three
categories
– Active Income/Loss
– Portfolio Income
– Passive Income/Loss
• Passive cannot offset portfolio or active
income
13-10
LO #2 – Passive Activities
• Rental Activities – usually passive
• Real estate professional exception
• Six other instances where rental is not
passive
–
–
–
–
–
Rental period less than seven days
30 day or less and significant personal services
Extraordinary personal services
Incidental to non-rental activity
Customarily available during defined business
hours
– Rented to an entity the taxpayer owns
13-11
LO #2 – Passive Activities
• $25,000 loss allowed for rental activities
– Active participation
– Own at least 10% of property
• Starts to phase out when AGI reaches
$100,000, not including the rental loss.
• Eliminated when AGI exceeds $150,000
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LO #2 – Passive Activities
• Disposition of a passive activity in a
taxable transaction.
– Passive losses are allowed against nonpassive income
– Suspended passive losses are permitted
– Gifts and inheritance do not trigger use of
suspended losses (does not meet taxable
transaction criterion)
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LO #2 – Passive Activities
Concept Check
1. Rental properties are almost always
considered passive activities.
True
2. The general rule concerning the deductibility
of passive losses is that they can be
deducted only to the extent of passive
income.
True
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LO #2 – Passive Activities
Concept Check
3. For low income taxpayers, passive rental
losses can be deducted against other
income up to a maximum of $50,000.
False
4. Generally, suspended passive losses can be
deducted against other income when the
activity is sold or disposed of. True or False
True
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LO #3 – At-Risk and PAL Rules In
Conjunction
• At-risk rules applied first then passive
loss rules second.
• Form 6198 for each at-risk activity
• Form 8582 – one for all passive
activities
• PAL do not come into play unless the
loss is first allowed under the at-risk
rules
13-16
LO #3 - Concept Check
1.
Which rules are applied first to a passive activity - the at-risk rules or
the passive activity losses rules? Explain?
In order for a loss to be deducted, it must first be allowed under the at-risk
rules. Once the loss is allowed under the at-risk rules, the passive
loss rules are applied.
2.
Why must suspended passive losses from several passive activities
be allocated among the activities?
The main reason is that passive losses are allowed when an activity is sold
or disposed of. Thus, if a taxpayer were considering the sale of a
passive activity, he or she could lump all suspended passive losses on
one activity and sell it. All of the losses would then be allowed. The
allocation to all loss activities stops this potential abuse.
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LO #3 - Concept Check
3. If a taxpayer has AGI of $105,000 before
considering a $23,000 loss from a rental
activity, how much can the taxpayer deduct
from the rental activity, if any?
The taxpayer is eligible for the $25,000 offset for
rental losses. However, the $25,000 limit is
phased out once the taxpayer’s AGI reaches
$100,000 [($105,000 - $100,000) × ½ =
$2,500]. Thus, only $22,500 of the rental
loss would be allowed.
13-18
LO #4 – Alternative Minimum Tax (AMT)
• AMT Formula
–
–
–
–
–
–
–
–
Regular taxable income
Plus exemptions and standard deduction
Plus/minus adjustment items
Plus tax preference items
Minus AMT exemption amount
Multiplied by 26% or 28% less $3,500
Tentative AMT less regular tax
Equals AMT
13-19
LO #4 – Alternative Minimum Tax (AMT)
• Adjustments – limits on itemized deductions
– Medical – AGI floor increased to 10%
– Taxes – not allowed for AMT
– Mortgage interest – must be to build, buy, or
improve residence
– Charity – no adjustment
– Casualty and theft – no adjustment
– Miscellaneous – not allowed for AMT
13-20
LO #4 – Alternative Minimum Tax (AMT)
• Depreciation adjustments
– Real property 1986 – 1999 – 40 years life
of all real property for AMT
– Real property after 1998 – no AMT
adjustment
– Personal property 1986 -1998 – longer life
and method change to 150% declining
balance
– Personal property after 1998 – method
change to 150% declining balance for AMT
13-21
LO #4 – Alternative Minimum Tax (AMT)
• Other adjustments
– Basis calculation for gains and losses
– Incentive stock options adjustment
– Adjustments from K-1s
– Long-term contracts
• Tax preference items – not much of an
issue any longer
13-22
LO #4 – Alternative Minimum Tax (AMT)
• Exemption amount
– Single
– MFJ
– MFS
$42,500
$62,550
$31,275
• Phase-out – exemption is reduced by
25% of AMTI in excess of income limits
– $112,500 single, $150,000 MFJ, $75,000
MFS
13-23
LO #4 – AMT
Concept Check
1. Medical expenses are allowed in full
(same as the regular tax) for AMT
purposes.
False
2. No taxes are allowed as a deduction
for AMT purposes.
True
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LO #4 – AMT
Concept Check
3. If a taxpayer is married and has eight
children, his personal exemptions for regular
tax purposes could be $33,000 (10
exemptions × $3,300) depending on his AGI.
None of this amount would be allowed for
AMT purposes.
True
4. If a taxpayer’s AMTI was under $175,000,
the AMT tax rate would be 26%. True or
False
True
13-25