1.
In this lesson we will discuss Passive Activity Losses.
2.
The tax law includes two sets of complex rules that limit the numerous opportunities which were
available to taxpayers under prior law to avoid or reduce their income tax liability through tax
shelter investments. These rules, the at-risk limitations and the passive loss limitations, are the
topics included in this lesson. The at-risk rules limit a taxpayer’s deductions from an investment
to the amount the taxpayer would stand to lose if the investment became worthless. The passive
loss rules stipulate the deductions attributable to passive activities may, as a general rule, be used
only to offset passive income. Thus, in most situations passive losses may not be used to offset
active or portfolio income.
3.
After completing this lesson, you should be able to: Discuss tax shelters and the reasons for at-
risk and passive loss limitations, Explain the at-risk limitation, Describe how the passive loss
rules limit deductions for losses and identify the taxpayers subject to these restrictions, Discuss
the definition of passive activities and the rules for identifying an activity, Analyze and apply the
tests for material participation, Understand the nature of rental activities under the passive loss
rules, Recognize the relationship between the at-risk and passive activity limitations, Discuss the
special treatment available to real estate activities, and
Determine the proper tax treatment upon
the disposition of a passive activity
4.
The passive loss and at-risk rules are complex rules so take your time when reviewing this lesson.
We will begin with the passive loss rules. The passive loss rules require the taxpayer to segregate
all income and losses into three categories: active, passive, and portfolio. In general, the passive
loss limits disallow the deduction of passive losses against active or portfolio income, even when
the taxpayer is at risk to the extent of the loss. In general, passive losses can offset ONLY passive
income. The passive loss rules are also subject to the at-risk rules which were designed to prevent
taxpayers from deducting losses in excess of their economic investment in an activity.
5.
Now we will discuss the at-risk rules in the next two slides. The at-risk provisions limit the
deductibility of losses from business and income-producing activities. These provisions, which
apply to individuals and closely held corporations, are designed to prevent taxpayers from
deducting losses in excess of their actual economic investment in an activity. The economic
investment in a company is defined as the amount of cash and adjusted basis of property
contributed to the activity plus amounts borrowed for which taxpayer is personally liable. The
initial amount considered at risk consists of the following: Losses from the activity only to the
extent that the taxpayer is at-risk Any losses disallowed due to at-risk limitation are carried
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- Spring '10
- man
- Taxation in the United States, passive loss rules
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