Passive loss limitation - married filing separate - HELP

[FEDUKE404]

Married couple has, for reasons they choose, been filing MFS for the last few years. They are both remarried and have lived together for all years, with one child being from a prior marriage.

Starting in 2012, rental property was obtained and Sch E entries resulted in a net passive loss. Accountant for that year gave spouse, per Form 8582, a net allowable (limited) passive loss of $12,500. The remainder was carried forward via the usual Form 8582 worksheets.

The rental property is titled in the name of one spouse, and the married couple is not approaching the limits where high AGI alone would preclude claiming any passive loss.

The rules, as I read them, state that because the husband/wife lived together, the allowable passive loss is therefore ZERO for a married filing separate return.

When the former (CPA) tax person was asked, this is part of the response: "Even though [they] resided together during the year, the separate income agreement is predicated on the fact that [they] were living independently of each other for purposes of income tax."

This person is also citing "that there was a separate income agreement that required that [they] file a separate return, reporting only [one spouse's] income."

It is my understanding there may have been some kind of pre-nuptial/family matter that might be a factor in creating the continuing married filing separately scenario, although I never heard of such an arrangement. It should be noted NC is not a community property state. What relevance, if any, could this separate issue have?

The more important issue is the obvious: With the facts given, I strongly feel there is no option that would allow a $12,500 passive loss for a married filing separate return when the spouses routinely live together. The net passive loss cannot exist via Schedule E / Form 8582. Bottom number on Sch E is zero, and all else goes to Form 8582 and future use.

Is there a salient exception I am missing? ? ?

Thanks for all input. (Calling Koss. . .)

FE

[DonB]

I agree with you. The instructions say no passive loss deduction for MFS if they lived together at any time during the year. I have always heard the IRS does not recognize civil agreements that are contrary to tax law.

[FEDUKE404]

Reposted

Since things have now (hopefully) calmed down with April 15th in the rear-view mirror, I thought I would bump this post to the top again.

Again, the issue is the "big city" CPA (using the weak "explanation" previously cited) gave the MFS a $12,500 passive loss in 2012. I cannot accurately prepare the 2013 returns until 2012 first gets resolved.

My personal opinion is the client will have to amend 2012, take a $0 net loss via Sch E / Form 8582, and move onward. Of course, for all intents and purposes that translates into $12,500 of new "income" that now requires an after-the-fact income tax payment.

Has anyone ever heard of this position being valid and/or accepted by the IRS? The rules are pretty clear to me: MFS, lived happily with spouse for all 12 months of 2012 and 2013, so allowable passive loss via Form 8582 is *zero* . Apparently the CPA is citing the pre-nuptial agreement (with current spouse) as a justification for ignoring the MFS passive loss rules. Is that possible??

What exception is the CPA using, or what explanation am I missing ??

Thanks.

FE

[Burke]

. Apparently the CPA is citing the pre-nuptial agreement (with current spouse) as a justification for ignoring the MFS passive loss rules. Is that possible??
What exception is the CPA using, or what explanation am I missing ??Thanks.FE

No, it is not permitted under the Internal Revenue Code, and therefore cannot be superseded by an agreement that is contrary to that.

[FEDUKE404]

Agreement excuse

No, it is not permitted under the Internal Revenue Code, and therefore cannot be superseded by an agreement that is contrary to that.

My guess is the CPA is now grasping for straws to justify his error and is somehow using the pre-nup (which I've never seen) as a convenient excuse.

I could be right. I could be wrong.

Additional problem is he is being a bit adamant in the "correctness" of his 2012 return, leaving me and the new client in the backflow.

FE

[buzzardbreath]

Living Apart

If they are in fact living apart, they might have the option of filing single or HH. Others will probably disagree with this position, but although the definition is statutory, the facts are often slippery as an eel.

Whatever power the judge may possess in civil matters, he cannot adjudicate them as "living apart for tax purposes." The former preparer cannot rely on this to allow a passive loss. This is obviously an attempt on his part to avoid a MFS status.

[FEDUKE404]

Couple lived/lives together

If they are in fact living apart, they might have the option of filing single or HH. Others will probably disagree with this position, but although the definition is statutory, the facts are often slippery as an eel.

The "new" married couple is quite happily living together and has done so for at least the last five years. Apparently, for reasons best known to them, they have elected to use married filing separately since they both remarried.

Thus, abandoned spouse or HOH or filing as a single person are all completely off of the table for 2012 and 2013 and . . .

The rental properties, which are generating the passive losses, first appeared on the client's scene for tax year 2012. This is a new (2013) client for me, and as is the norm I asked for copies of recent tax returns. The rest is history.

FE

[Roland Slugg]

The law (Code §469(i)(5)(B)) is crystal clear on this point, the spouses' side agreement not withstanding.

Seems to me the sensible thing to do would be to revert to a MFJ return via an amended return. (If they do this, they might be rewarded with an even greater tax outcome than simply the preservation of the special $25,000 special PAL allowance.) If the parties won't agree to do that, whichever one(s) deducted $12,500 on his/her 2012 return should amend that return.

Whether they amend the prior year or not, you should prepare their 2013 returns properly by not claiming any portion of the special $25k allowance on their 2013 returns if they wish to continue with their foolish MFS filing status.

The issue will become a dilemma when there is overall passive income, including the prior years' C/Os. If they haven't filed amended MFS returns or an amended MFJ return for 2012, the question of "how much is the PAL carryover to 2013?" will arise, and you won't have an answer.

[FEDUKE404]

Considering MFJ filing

The law (Code §469(i)(5)(B)) is crystal clear on this point, the spouses' side agreement not withstanding.

Seems to me the sensible thing to do would be to revert to a MFJ return via an amended return. (If they do this, they might be rewarded with an even greater tax outcome than simply the preservation of the special $25,000 special PAL allowance.) If the parties won't agree to do that, whichever one(s) deducted $12,500 on his/her 2012 return should amend that return.

Whether they amend the prior year or not, you should prepare their 2013 returns properly by not claiming any portion of the special $25k allowance on their 2013 returns if they wish to continue with their foolish MFS filing status.

The issue will become a dilemma when there is overall passive income, including the prior years' C/Os. If they haven't filed amended MFS returns or an amended MFJ return for 2012, the question of "how much is the PAL carryover to 2013?" will arise, and you won't have an answer.

I agree with your assessment essentially 100%.

At this time I have no knowledge of the spouse's income for 2012 and/or 2013. There are some personal (and perhaps cultural?) obstacles in play where it appears both sides are quite content with continuing the MFS option. So far as I know, that has been their choice for several years, regardless of any obvious "tax savings," to include the 2012 arrival of the rental passive loss properties.

The most likely outcome, at this point, is to amend the 2012 tax returns (US + two states involved) to negate the passive loss, i.e. more or less raise the spouse's taxable income by $12,500. That will give me the proper numbers to move forward on the 2013 returns. (It would be nice if the "big city CPA" would own up to his 2012 error, instead of hiding behind his excuses which appear to be bogus.) If the client is amenable to that approach, I will move onward.

Thanks very much for your input!

FE