Active Participation.
This is different than material participation and generally relates to real estate properties.
You can qualify for $25000 deduction even if you are actively participating as long as you are not materially participating or meet the real estate professional rules.
Real Estate Professional Rules
If you are a real estate professional (spend more than 50% of your personal service time in real estate or related business) or if you work more than 750 hours on real estate related activities (unless you are an employee and own less than 5%) then you are not able to qualify for active participation and the income can’t offset anything other than passive income.
Accelerated Deductions
Conduit entities can provide taxpayer benefits through accelerated deductions for personalty and straight line deductions for realty property.
Tax Credits
Conduits allow tax credits to flow through to personal taxes.
Historic Tax Credit - restoring eligible historical buildings results in up to 20% of the cost credited.
Low Income Housing Credit is another
At-Risk Rules
Applied prior to Passive Activity Loss Rules
Essentially, you cannot lose more than your basis in the investment.
Except for in real estate, then it’s your proportionate share of qualified non-recourse financing in real estate. (so you can’t lose what your liability is if the liability is debt - only the cash you put in)
This is because it’s non-recourse debt meaning that the investor doesn’t have personal liability or collateral against the debt.
Conduit
Also known as Direct Participation Programs.
S corp
Partnerships
Fractional interest in entity
LLC and LLP
Not for inexperienced investors.
Pass through entities.
Direct Participation Program
These are also known as conduits and represent investment vehicles where the investor still has direct management engagement in the income, deductions, and credits of the business.
Partnerships
S Corps
Fractional interest of direct ownership (joint tenancy, tenancy in common, and tenancy by entirety)
LLCs and LLPs can also be used.
Not for inexperienced investors.
Limited Partnership
Most common form of direct participation program.
Historically called a tax shelter investment.
Master Limited Partnership
Partnership where units of company are sold on stock exchange - meaning high liquidity.
Omnibus 1986 act reduced capabilities so now most of these are not conduits.
Material Participation
Essentially boils down to “is this passive income or not”
Did the taxpayer:
1. Work there more than 500 hours per year?
2. Does the participation constitute substantially all of the work necessary?
3. Do they participate for mroe than 100 hours and is that equivalent to other participants?
4etc.
If the person works more than 500 hours there or does most of the work but it takes less time than that - then they are material participators and PAL rules don’t apply.
Non-publicly Traded Partnership
These are usually RELPs and losses are allowed to offset any other non-publicly traded partnership income. Not investment specific like publicly traded partnerships.
Passive Activities
Any income producing program in which the participation of the investor is not regular, continuous, and substantial.
These can create passive income or loss. But passive activity loss rules apply and determine the deductibility of losses.
IRS lists two kinds:
1. Trade of business activities in which taxpayer does not materially participate
2. Rental activities, even if the taxpayer is a material participant, unless the taxpayer is also a real estate professional.
Passive Activity Loss Rules
This rule states that passive losses can only offset passive gains. They cannot offset earned income or investment income streams.
Applies to:
Individuals
Estates
Trusts
Personal Service Corporations
Applies partially to:
Closely Held C Corporations (can offset against active, but not investment)
Partnership Entities
Limited Partnership
General Partnership
Master Limited Partnership
LLC and LLP (if not taxed as corporation)
Allow limited liability (except general).
Limited partnership is most common used direct participation program and historically referred to as a tax shelter.
General partnerships not common due to risk.
MLPs were common before 1986, now there are specific rules for publicly traded partnerships. Most are not treated as conduit entities now.
Publicly Traded Partnership
Also known as master limited partnerships.
These are partnerships where the units of the business are available to be traded on the stock exchange. This makes them highly liquid.
1986 the Omnibus Budget Reconciliation Act tightened restrictions and now most are not conduit entities.
MLPs must be considered separately, they cannot be netted into gains or losses overall.
Publicly traded partnership losses can ONLY offset publicly traded partnership gain from the same company OR upon sale of the entire interest.
Real Estate Limited Partnership (RELP)
These are non-publicly traded limited partnerships in real estate ventures.
Losses from these can only be offset by income from another non-publicly traded limited partnership - but it doesn’t have to come from the exact same one.
Rental Real Estate Activities
Real estate activities are inherently passive.
Unless real estate professional who works more than 750 hours per year or more than 50% of personal services are real estate realted.
If qualify, you can deduct up to $25k in losses each year if you make less than $100 and are not married filing jointly.
If you make over $100k, then it is $25k - (.5X amount over 100k) and you can deduct up to that new max.
This is for the $25k to be treated as active losses, if you are above the threshhold, then it is passive losses.
Suspended Loss
A tax loss disallowed because of the at risk rules.
May be used in either the first year where the at risk amount is sufficient to absorb the loss, or upon sale.
If upon sale, loss is limited the at risk amount.
Can be carried forward.
Passive Loss vs Gain Reminder
“Every PIG needs a PAL”
Passive Income Generator
Passive Activity Loss.
If there are multiple passive activities, they offset each other in proportion to the total loss.
1- (40,000)
2 - (20,000)
3 - 15000
Net loss is (45000)
so to deduct:
40k/60k = 2/3
2/3 * (45000) = $30000 allocated to activity #1
20k/60k = 1/3
1/3 *45000 = 15,000
30k + 15K = 4500
Tax-Shelter Investments
Prior to 1986 these were programs created specifically for tax motivated reasons that were designed to generate losses to defer or eliminate investor’s tax liabilities.
These are now governed by:
At Risk Rules
Passive Activity Loss Rules
S Corporations
Limited partners who do not materially participate in the operation of the company may consider these passive income sources
Special Allocations
This is a provision that allows limited partners to share unequally in the deductions, income, etc. of the company.
IE - if a partner donates a solely owned warehouse to the company, they may request a special allocation to get all the deductions for the space.
Borrowing
Tax Shelters may use debt to boost the amount of deductions available to taxpayers.
$100k cost and $900k debt allows for a much bigger deduction.
At risk rules apply
Disposition of passive activities/Suspended losses and carryovers
If a taxpayer disposes of their entire interest in a fully taxable transaction to a non-relative then the suspended losses and losses incurred in that year are deductible.
Offset gain from the transaction first, then other passive incomes. If there is remaining suspended losses - it carries forward as active loss and can be used for earned income in the future.
At risk rules still apply, so if the loss is not allowed per at risk rules, it is not a suspended loss eligible for deduction and must be carried forward to use against future passive income.
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Module 1 - Income Tax Fundamentals and Calculations70
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Module 2 - Investment Vehicle Taxation, NII, Additional Medicare Tax, and Education Planning62
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Module 3 - Tax Reduction and management techniques47
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Module 4 - Special Circumstances25
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Module 5 - Essentials of Business Entity Taxation39
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Module 6 - Consequences of Property Transactions68
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Module 724
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Module 8 - Tax Law and Compliance and Procedures46
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Reminders after Quizzes81
