Income and Losses (Active)
Wages, Salaries , Bonuses ,Income from Self employment, gain from disposition of an asset, income from intangible property. (Earned Income)
Income and Losses (Portafolio)
-Royalties, capital gains, annuities, dividends, interest income
-Gain or loss from the disposition of property that produces portfolio income or is held for investment purposes.
-unearned income
Income and Losses( Passive activity )
-any trade or business (usually partnerships) in which the taxpayer doe not materially participates (they are just investors, they do not run the business)
-rental activities are considered passive income, whether the taxpayer materially participates or n
if you are a real state professional
rental activity is not considered passive income and passive loss limitations rule do not apply
Rental real state
-passive activity
-generate passive losses
(2) exceptions
- real state professional : more than half of your services or 750 hours are in real property business, you will not be subject to passive loss limitation rules and your loss will be considered ord
Passive Losses
- are recorded on taxpayers 1040
- passive losses can only offset passive income
-Passive losses are also subject to the at-risk rules
Tax Loophole
the losses generated by these passive activities (partnerships) were allocated among investors by the ownership percentage. because there was no limitations, investors were able to deduct huge amount of losses and deductions
Tax Shelters
transactions made for the sole purpose of generating losses and reducing operating income are called tax shelters
IRS Reaction
Tax shelters have to be registered with the IRS
IRS created 2 rules to close this loophole on those tax shelters
At-Risk limitation rule and passive loss limitation rules
At-Risk limitation rule and passive loss limitation rules
they limit the amount of losses tax payers can deduct on their 1040
According to IRS
taxpayers are able to deduct the losses from partnerships only up to the amount the taxpayer is at risk
At-Risk amounts (Ending balance rolls over to future years)
- cash plus the adjusted basis of property contributed to the activity
-plus borrowed amounts for which the taxpayer has personal liability or has pledged as security property not used in the activity.
-Plus the taxpayers share of amounts borrowed for use
Recourse debt definition
when the taxpayer is personally liable for a loan. creditors are allowed to go after the taxpayers personal assets.
NonRecourse Debt
is debt for which the borrower is not personally liable (e.g., a
mortgage on real estate acquired by a partnership without the assumption of any
liability for the mortgage by the partnership or any of the partners, with the
acquired property pledged as co
Qualified nonrecourse financing
-Treated as Recourse
-it will increase your amounts at risk
-secured by real property used in the activity
What Increases the taxpayer's at-risk amounts?
-Cash and the Adjusted bases of property contributed to the activity
-libilities ( amounts borrowed for use in the activity for which the taxpayer is personally liable or has pledged as security property not used in the activity
- Taxpayer's share of amou
What decreases the taxpayer's at-risk amounts?
-Withdrawals from the activity (distributions from the business )
-Taxpayer's share of the activity's loss (losses from the business)
-Taxpayer's share of any reductions of debt for which recourse against the taxpayer exists or reductions of qualified non
At-Risk Limitation Rules
- losses from passive activities will be limited to the at-risk amount
- they will always be applied first to each activity to determine maximum amount of loss allowed for year
Passive Loss Limitation rule
- Passive losses cannot offset any other type of income on your 1040
- if your don't have passive income, then you can not take the passive loss
- this rule is applied after you applied the at- risk limitation rule
if your passive loss passes to the 2 rules
then it will show on your 1040
what if the loss from the business exceeds the at risk amount?
ex. 40k loss and 20 k at risk amount
At risk amount Beg Balance - 20,000
loss from Passive activity (40,000)
end balance at risk amount 0
-20,000 is deductible and subject to the passive loss limitation rule ( is there any passive income that will be offs
why do u Suspend losses
when you do not have enough amounts at risk you have to suspend the loss and carry it forward to next year and you can do this indefinetily until you have enough amounts at risk or until you sale your share in the partnership.
-Losses can be suspended due
Material Participation
An activity is treated as active rather than passive (thus, not subject to the passive loss limits) if taxpayer meets one of 7 material participation tests
Test for Material participation
1. the taxpayer participates in this activity more than 500 hours per year (they are material participant)
1b any hours worked or generated by the spoused also count as the 500 hours of the taxpayer
2. if you have employees , your have to work the most am
Examples
...
Ken has a $40,000 loss from an investment in a partnership in which he does not materially
participate. He paid $30,000 for his interest. How much of the loss is disallowed by the at-risk
rules? How much is disallowed by the passive loss rules?
The at-risk limits disallow $10,000 of the deduction ($40,000 loss - $30,000 at
risk). Ken is not a material participant, so the remaining $30,000 is disallowed by
the passive loss rules.
Sarah purchased for $100,000 a 10% interest in a business venture that is not subject to the passive activity rules. During the first year, her share of the entity's loss was $120,000. At the beginning of the second year, the entity obtained $800,000 of r
(a) Suspended loss at the end of first year $ 20,000
(a) At-risk amount at the end of second year $ 15,000
(B) Suspended loss at the end of second year $ -0-
what is the significance of the term material participation ? why is the extent of a taxpayers participation in an activity important in determining whether a loss from an activity is deductible or nondeductible?
The term material participation is significant from the taxpayer's perspective
because losses from a nonrental activity in which the taxpayer materially participates can
offset active and portfolio income. Material participation is determined by the level
John , an engineer, operates a separate business that he acquired eight years ago . if he participates 85 hours in the business and it incurs a loss of 34000 , under what circumstances can john claim an active loss
John is entitled to treat the loss as active if his participation constitutes substantially
all of the participation in the activity of individuals (including nonowner employees) for the year. If John is the only individual who participates in the activit
in the current year, Ed invests $30,000 in an oil partnership .He has taxable income for the current year of $2000 from the oil partnership and withdraws $ 10,000 . what is Ed's at risk amount at the end of the year?
Ending at-risk amount $22,000
Rhonda has an adjusted basis and an at-risk amount of 7,500 in a passive activity at the beginning of the year. she also has a suspended passive activity loss of 1500 carried from prior year. during the current year, she has a loss of 12,000 from the pass
(a) Ending adjusted basis and at-risk amount $ 0
(b)The current passive loss is $12,000. Because $7,500 of the loss is used to reduce
the at-risk amount to $0, $4,500 is suspended under the at-risk rules ($12,000 ? $7,500 = $4,500).
(c) The $7,500 loss th
Dorothy acquired a 100% interest in two passive activities: activity A in January 2011 and Activity B in 2012.through 2014, Activity A was profitable, but it produced losses of $200,000 in 2015 and $100,000 in 2016. Dorothy has passive activity income fro
In 2014 and 2015, Dorothy may deduct none of the net passive losses that remain after
offsetting the passive income. In 2014, the $20,000 of passive income is used to absorb $20,000 of the $200,000 passive loss, leaving $180,000 of passive loss suspended.