Lecture - 1 2 In this lesson we will discuss Passive Activity Losses The tax law includes two sets of complex rules that limit the numerous

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