Week 4 Project
Fundamentals of Taxation 2020 Edition Cruz, Deschamps, Niswander, Prendergast, Schisler
Chapter 13
At-Risk/Passive Activity Loss Rules and the Individual Alternative Minimum Tax
“Never let the tax tail wag the economic dog.”
-- Laura Peebles
© 2020 McGraw-Hill. All rights reserved. Authorized only for instructor use in the classroom.
No reproduction or further distribution permitted without the prior written consent of McGraw-Hill.
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Learning Objective #1- At-Risk Rules 1
At-risk activities include any “engaged…in carrying on a trade of business or for the production of income.”
Initial amount at-risk is any contribution of money plus the adjusted basis of contributed property.
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An activity is “at-risk” if the taxpayer has something to lose. At-risk starts with the amount of money and property the taxpayer contributes to an activity.
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Learning Objective #1- At-Risk Rules 2
What is “at-risk” or increases “at-risk”?
Cash and property contributions.
Share of liabilities.
Income and gain items.
What decreases “at-risk”?
Cash and property distributions.
Release of liabilities.
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At-risk is increased by contributions, income items, and by an increase in the taxpayer’s share of liabilities. Conversely, distributions, loss items, and releases of liabilities decrease at-risk.
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Learning Objective #1- At-Risk Rules 3
Form 6198 is filed for each activity subject to the at-risk limitations.
Liabilities can affect at-risk amount.
Recourse debt.
Nonrecourse debt.
Qualified nonrecourse debt.
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Liabilities can be recourse, nonrecourse, or qualified nonrecourse. Recourse and qualified nonrecourse liabilities increase the taxpayer’s at-risk amount.
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Learning Objective #1- At-Risk Rules 4
Losses disallowed under the at-risk rules.
Carried over indefinitely.
Deducted in years when the at-risk amount increases.
Losses may still be subject to the passive loss limitations.
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Losses are only allowed to the extent a taxpayer is at-risk for an activity. If a loss is disallowed under the at-risk rules, the loss is carried over indefinitely and is allowed when the at-risk amount increases in future years.
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Learning Objective #1- At Risk Rules Concept Check 13-1 1
Which of the following items will increase a taxpayer’s at-risk amount?
a. A cash contribution made by the taxpayer into the activity.
b. The taxpayer’s share of income from the activity.
c. The taxpayer’s share of the activity’s liabilities for which the taxpayer is personally liable.
d. All of the above.
Answer: D
Which of the following types of liability does not increase the taxpayer’s at-risk in an activity?
a. Non-recourse debt.
b. Recourse debt.
c. Qualified non-recourse debt.
d. All of the above increase at-risk.
Answer: A
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Learning Objective #1- At Risk Rules Concept Check 13-1 2
When a loss is disallowed by the at-risk rules, which of the following is true?
a. The loss is lost forever.
b. The loss can be used only upon the activity’s disposal.
c. The loss is indefinitely carried forward.
d. The loss can be used only if the taxpayer makes a contribution to the activity.
Answer: C
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Learning Objective #2 – Passive Activities 1
What is a Passive Activity?
Taxpayer does not materially participate on a
Regular.
Continuous.
Substantial basis.
Most rental activities and limited partnership interests are passive by definition.
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A passive activity is any activity where the taxpayer does not “materially participate.” Rental activities and limited partnership interests are almost always considered passive.
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Learning Objective #2 – Passive Activities 2
Seven tests for material participation:
> 500 hours.
All of the participation in the activity.
> 100 hours and not less than any other person.
> 100 hours and several activities that in aggregate exceed 500 hours.
Material participant for any of the last five years of ten years.
Material participant for any of last three years for personal service activity.
Facts and circumstances.
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There are seven tests to determine if a taxpayer is a material participant in an activity. The most common test is that the taxpayer worked in the activity for greater than 500 hours during the tax year.
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Learning Objective #2 – Passive Activities 3
Passive Losses – General Rule:
Passive losses are allowed only to the extent of passive income.
Income/loss items separated into three categories:
Active Income/Loss.
Portfolio Income.
Passive Income/Loss.
Passive losses cannot offset portfolio or active income.
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The general rule for passive losses is: passive losses are allowed only to the extent of passive income. In other words, passive income cannot offset portfolio or active income.
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Learning Objective #2 – Passive Activities 4
Rental Activities – usually passive.
Real estate professional exception.
Six other instances where rental is not passive:
Rental period less than seven days.
30 days or less and significant personal services.
Extraordinary personal services.
Incidental to non-rental activity.
Customarily available during defined business hours.
Rented to an entity the taxpayer owns.
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Although rental activities are usually considered passive, there are several instances where rental activities are not passive. If the taxpayer is a real estate professional or the activity meets one of the other six criteria, the rental activity is not considered passive.
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Learning Objective #2 – Passive Activities 5
$25,000 loss allowed for rental activities.
Active participation.
Own at least 10% of property.
Starts to phase out when A G I reaches $100,000, not including the rental loss.
Eliminated when A G I exceeds $150,000.
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A $25,000 loss offset is allowed for rental properties for lower income taxpayers. The $25,000 loss allowed is phased out as the taxpayer’s AGI reaches $100,000.
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Learning Objective #2 – Passive Activities 6
Disposition of a passive activity in a taxable transaction.
Passive losses are allowed against non-passive income.
Suspended passive losses are permitted.
Gifts and inheritance do not trigger use of suspended losses (does not meet taxable transaction criterion).
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When a passive activity is disposed of, suspended passive losses are permitted against non-passive income.
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Learning Objective #2 – Passive Activities Concept Check 13-2 1
Rental properties are almost always considered passive activities. True or false?
True
The general rule concerning the deductibility of passive losses is that they can be deducted only to the extent of passive income. True or false?
True
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Learning Objective #2 – Passive Activities Concept Check 13-2 2
For low-income taxpayers, passive rental losses can be deducted against other income up to a maximum of $50,000. True or false?
False
Generally, suspended passive losses can be deducted against other income when the activity is sold or disposed of. True or false?
True
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Learning Objective #3 – At-Risk and P A L Rules in Conjunction
At-risk rules applied first, then passive loss rules second.
Form 6198 for each at-risk activity.
Form 8582 – one for all passive activities.
PAL rules do not come into play unless the loss is first allowed under the at-risk rules.
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The at-risk rules and the passive loss rules work together to limit losses. The loss must first pass through the at-risk rules and then the passive loss rules are applied to determine the deductibility of the loss.
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Learning Objective #3 - Concept Check 13-3 1
Which rules are applied first to a passive activity - the at-risk rules or the passive activity losses rules? Explain.
In order for a loss to be deducted, it must first be allowed under the at-risk rules. Once the loss is allowed under the at-risk rules, the passive loss rules are applied.
Why must suspended passive losses from several passive activities be allocated among the activities?
The main reason is that passive losses are allowed when an activity is sold or disposed of. Thus, if a taxpayer were considering the sale of a passive activity, he or she could lump all suspended passive losses on one activity and sell it. All of the losses would then be allowed. The allocation to all loss activities stops this potential abuse.
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Learning Objective #3 - Concept Check 13-3 2
If a taxpayer has A G I of $105,000 before considering a $23,000 loss from a rental activity, how much can the taxpayer deduct from the rental activity, if any?
The taxpayer is eligible for the $25,000 offset for rental losses. However, the $25,000 limit is phased out once the taxpayer’s A G I reaches $100,000 [($105,000 − $100,000) × ½ = $2,500]. Thus, only $22,500 of the rental loss would be allowed.
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Learning Objective #4 – Alternative Minimum Tax (A M T) 1
A M T Formula:
Regular taxable income.
Plus exemptions and standard deduction.
Plus/minus adjustment items.
Plus tax preference items.
Minus A M T exemption amount.
Multiplied by 26% or 28% less $3,896.
Tentative A M T less regular tax.
Equals A M T.
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The AMT is a separate tax structure to ensure high income taxpayers pay tax. The starting point of AMT is the taxpayer’s regular taxable income.
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Learning Objective #4 – Alternative Minimum Tax (A M T) 2
Adjustments – limits on itemized deductions.
The 2017 Act simplified the itemized deductions.
Medical, mortgage interest, charity, and miscellaneous deductions are treated the same for regular tax and AMT purposes.
Only Itemized deduction adjustment will be taxes.
Taxes are limited to $10,000 on Schedule A but no deduction is allowed for A M T.
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No state/local tax deduction is allowed in the AMT calculation.
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Learning Objective #4 – Alternative Minimum Tax (A M T) 3
Depreciation adjustments:
Real property 19 87–19 99 – 40 years life of all real property for A M T.
Real property after 19 98 – no A M T adjustment.
Personal property 19 87–19 98 – longer life and method change to 150% declining balance.
Personal property after 19 98 – method change to 150% declining balance for A M T.
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For personal property, the depreciation method allowed for AMT is 150% declining balance as opposed to 200% declining balance for regular tax purposes.
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Learning Objective #4 – Alternative Minimum Tax (A M T) 4
Other adjustments:
Basis calculation for gains and losses.
Incentive stock options adjustment.
Adjustments from K-1s.
Long-term contracts.
Tax preference items – not much of an issue any longer.
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Other major AMT adjustments include incentive stock options and accounting for long-term contracts.
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Learning Objective #4 – Alternative Minimum Tax (A M T) 5
Exemption amounts for 2018:
Single $ 71,700
M F J $111,700
M F S $ 55,850
Phaseout – exemption is reduced by 25% of A M T I in excess of income limits.
$510,300 single, $1,020,600, M F J, $510,300 M F S.
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To shield lower income taxpayers from the AMT, exemption amounts are subtracted from AMT income to reduce the amounts subject to the AMT tax rates of 26% or 28%. These exclusions are phased-out as the taxpayer AMTI exceeds certain thresholds.
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Learning Objective #4 – A M T Concept Check 13-4 1
Medical expenses are allowed in full (same as the regular tax) for A M T purposes. True or false?
True
No taxes are allowed as a deduction for A M T purposes. True or false?
True
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Learning Objective #4 – A M T Concept Check 13-4 2
If a taxpayer is married and has eight children, no exemption would be allowed for A M T purposes. True or false?
True
If a taxpayer’s A M T I is $194,800 or less, the A M T tax rate would be 26%. True or false?
True
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