Carryover passive losses

[rkamp]

Client has 4 rental properties. His income is $300,000 and has $80,000 in passive losses to date for all of the properties. Clients sells one of the properties and has a $500,000 capital gain. The software is allowing all $80,000 in suspended passive losses to be used to offset this gain. Is this correct or can I only take the passive losses related to the sold property? Do the return manually, it looks like I can take the suspended passive losses for all of the properties, but I can't find any documentation supporting this.

Thanks,

RIck

[Nashville]

The Whole Thing

Rick - you get to apply the whole $80K, not just that portion which applies to the sold property. See the worksheets supporting Form 8582.

Perhaps (and who can know the mind of the govt) the reason you are entitled to this, is because you are NOT entitled to pick and choose only bits and pieces of the impounded loss to apply against certain properties. You are forced to prorate, both when building and relieving the trapped losses.

Your client's losses are all wiped out. If he has any more, he starts all over again.

[les grans]

rkamp, when you wrote "The software is allowing all $80,000 in suspended passive losses to be used to offset this gain" did you really mean to say that the software is allowing the $80,000 in suspended passive losses to be deducted as an ordinary loss on Schedule E?
They - the losses - should not reduce the "capital gain", they should be allowed as deductible rental, i.e., ordinary, losses.

[Nashville]

Capital Gain Offset

They - the losses - should not reduce the "capital gain", they should be allowed as deductible rental, i.e., ordinary, losses.

LesGrande, I believe these pent-up losses will apply first to rental income (if profitable), and then to capital gains if the rental income fails to absorb the entire $80,000. I'm not the ultimate knowledge on this, however. Would love to hear from someone else.

[rkamp]

Rick - you get to apply the whole $80K, not just that portion which applies to the sold property. See the worksheets supporting Form 8582.

Perhaps (and who can know the mind of the govt) the reason you are entitled to this, is because you are NOT entitled to pick and choose only bits and pieces of the impounded loss to apply against certain properties. You are forced to prorate, both when building and relieving the trapped losses.

Your client's losses are all wiped out. If he has any more, he starts all over again.

My first thought was that all losses would be wiped up, too. But, the IRS auditor is saying that I can only take the losses associated with the sold rental unit, not the other suspended losses. From the IRS publications, the interpretation is confusing. The 8582 does say to put all suspended losses on the worksheet for all passive activity.
Does anyone know of IRC to support taking the full amount of ALL suspended losses for ALL rental passive activity?

[DTS]

Losses

rkamp,

Check out these two links and see if there is something here that may help you. The second link gives a good example of multiple units and only one of them being sold.

http://www.aicpa.org/pubs/taxadv/online/may2008/casestudy.html

http://www.accurate-accounts.com/passive.pdf

Dennis

[joanmcq]

Its my understanding that not only do all the losses get freed up, but they are first applied against rental income and then deducted on line 17 of the 1040. They do not net against the capital gains. At least that's what happened when I sold my rental!

[DTS]

Losses

I have a client where this issue came up this year and a possible sale in '08 or '09. She is totally limited.

I went in and did a "sale". My software is only allowing the losses, current and losses that were carryforward from past years to be used for the unit "sold". The losses from the unit still in possession are still suspended.

(added) I would like the area to research this in case there is an error in calculation on the software. I failed to say in my post that all units (homes) are tracked individually, not as one unit, which is the only way I see taking all the losses at once can be done.

Dennis

[FEDUKE404]

Another thought

I agree Form 8582 could probably force a priest to utter four-letter words....

One technicality I seem to (dimly) recall is that a property once sold ceases to be passive property in the year of sale. This means the gain from the sale of that specific property can be reduced by unused losses for that property, with all else being a gain/loss reported on Form 4797 and/or Sch D. The excess does not "help out" the other properties.

This differs from the scenario where there are several passive properties, and income above expenses ("a good year") for that unsold property CAN then be used to offset losses from other passive properties.

The devil is in the details - put the numbers in various places (other properties) and see what your software comes up with for the worksheets associated with Form 8582. (It may be as simple, for this illustrative purpose, as going back and saying the property was "not" disposed of but still using the same dollar amounts.)

TGFC ("Thank goodness for computers!!)

FE

[Bees Knees]

My first thought was that all losses would be wiped up, too. But, the IRS auditor is saying that I can only take the losses associated with the sold rental unit, not the other suspended losses. From the IRS publications, the interpretation is confusing. The 8582 does say to put all suspended losses on the worksheet for all passive activity.

Does anyone know of IRC to support taking the full amount of ALL suspended losses for ALL rental passive activity?

Tell the auditor to follow the worksheet instructions. The worksheet is correct.

TheTaxBook, page 7-10 says:

Passive Activity Loss Limits
A taxpayer cannot deduct losses from passive activities in excess
of income from passive activities in any given tax year. Losses
that are not allowed under these rules are allocated among the
taxpayer’s passive activities and carried over to future years. Suspended
losses are allowed as a deduction in the year the activity
is fully disposed of in a taxable transaction.

Notice that the passive loss limitations apply to all activities as a group, unless we are talking about a Publicly traded partnership under the old rules where passive income from such an activity could not be allocated to other activities with passive losses.

The question: Is the gain upon disposition of a passive activity considered passive income that can be allocated to other passive activities with suspended losses?

The answer is yes.

IRC Section 469(g) says:

(g) Dispositions of entire interest in passive activity

If during the taxable year a taxpayer disposes of his entire
interest in any passive activity (or former passive activity), the
following rules shall apply:

(1) Fully taxable transaction

(A) In general

If all gain or loss realized on such disposition is
recognized, the excess of—

(i) any loss from such activity for such taxable year
(determined after the application of subsection (b)), over
(ii) any net income or gain for such taxable year from
all other passive activities (determined after the
application of subsection (b)),

shall be treated as a loss which is not from a passive activity.

Notice this code section is referring to the excess loss from the disposition of the passive activity over all other passive income from all other passive activities. And that this amount is then treated as a non-passive loss. In other words, that excess loss over all other passive income is fully deductible because it is no longer considered a loss from a passive activity.

To carry this rule one step further, that then means that the income or loss from the disposition of the passive activity is FIRST netted against all other passive activities. So if the disposition produces a gain, that gain gets used to offset all other suspended passive losses from all other passive activities. It is only when excess losses from the disposition of the activity exceed all other passive income that it gets put into the non-passive category. Until that happens, the gain or loss from the disposition of the passive activity is netted against gain or loss from all other passive activities, including suspended losses.

[rkamp]

Bees,

Thanks so much for the information. You provided exactly the ammunition I was looking for!

Regards,

Rick Kamp, EA

[les grans]

Don't do the IRS auditor's work for him/her. And don't waste your client's time trying to educate the IRS agent, either. Tell him/her you disagree and "suggest" that he/she take the issue back to his/her office and ask others with more experience how the passive gains and losses net out.
DTS's software is also giving the wrong result. Is there a box that needs to be checked that indicates "total and taxable disposition" of the sold passive rental activity?
Whoever did Form 8582 "by hand" should be commended. I think the result was correct, too.
Bees' cite to the IRC is totally correct, of course. If you don't understand it, read it again.
And the "capital gain" from the sale is not reduced by the suspended passive rental losses, which are ordinary losses and should be reported on Schedule E. I put "capital gain" in quotes, because this gain is probably a section 1231 gain, and should be [first] reported on Form 4797, and then get carried over to Schedule D. And part of it is probably an "unrecapured section 1250 gain" which will be taxed at a different rate - maybe - after it's carried to Schedule D.
Trust me, I used to do this for a living...

[joanmcq]

What happens is the gain on the sale becomes 'income' from the property for purposes of form 8582 and the allocation of allowable losses that free up takes advantage of the additional income.

I had to do the 8582 worksheets by hand in grad school. I'm very glad for computers too.