IRC 469 Passive Activities Part 3 PAGI PAD PAI PAL 1 PAL General Rule Loss from passive activity is only usable against income from a passive activity Individuals can t use PAL against active or portfolio income Sometimes what seems to be PAGI will be treated as not PAGI recharacterization rules 469 i Special rule for dispositions generally an activity s PAL is triggered upon taxable disposition of the activity 2 PAL PAGI PAD and relevance 469 d 1 PAL excess of aggregate losses from all passive activities for the year over aggregate income from all passive activities for the year PAGI an item of gross income if and only if such income is from a passive activity PAD if and only if such deduction i Arises within the meaning of paragraph d 8 of this section in connection with the conduct of an activity that is a passive activity for the taxable year or ii Is treated as a deduction from an activity under 1 469 1T f 4 for the taxable year More details in 2 and 2T regs So some netting involved but must track PAL per activity so know how much suspended PAL might be triggered if activity disposed of Special rules for gains from dispositions portfolio and personal service income Ordering rules relevant if the loss is also subject to passthrough basis limitations 465 and capital loss limitations discussed later Calculations on Form 8582 3 PAL 1 469 2T b Generally excess of passive activity deductions for the year over passive activity gross income for the year Different definition used for closely held corporation 1T g PAL excess of PAD over PAGI net active income Basically just can t use PAD against portfolio income but see 1T g for details not necessary for BUS 225K 4 What is PAGI 1 469 2T c Gross income from a passive activity Not portfolio income Unless derived in ordinary course of the trade or business such as interest earned by a bank Not income from personal services PAGI does not include compensation paid to or on behalf of an individual for personal services performed or to be performed by such individual at any time 5 Portfolio income PLR 201005016 S corp earned interest on construction loan proceeds it received Held the interest income is portfolio income Not derived in the ordinary course of a trade or business No exception for interest arising from working capital Starting in 2013 3 8 Medicare tax on unearned income of high income individuals and trusts starts 1411 Will approach of the 469 regs be used to define unearned or net investment income 6 PAGI Questions Partnership owns one rental property Had CODI in 2010 of 40 000 Is it PAGI Your client owns an apartment building and is required to keep security deposits in separate account Earns 1 000 of interest income each year 1 2 3 Q Portfolio or rental income Client earns royalties from business of licensing movie rights Q Portfolio or trade business income 7 More PAGI Questions 4 5 6 Positive 481 a adjustment Income from a covenant not to compete Gross income or gain allocable to business or rental use of a dwelling unit for any year in which 280A c 5 applies 8 PAGI disposition gain rules General rule 2T c 2 Treatment of gain Except as otherwise provided in the regulations under section 469 any gain recognized upon the sale exchange or other disposition a disposition of an interest in property used in an activity at the time of the disposition or of an interest in an activity held through a partnership or S corporation is treated in the following manner 1 The gain is treated as gross income from such activity for the taxable year or years in which it is recognized 2 If the activity is a passive activity of the taxpayer for the taxable year of the disposition the gain is treated as passive activity gross income for the taxable year or years in which it is recognized and 3 If the activity is not a passive activity of the taxpayer for the taxable year of the disposition the gain is treated as not from a passive activity Interest in p s and S corp stock are not property used in a PA 9 Classification of disposition gain 1 1 1 469 2T c and 2 c 12 month lookback rule if property used in more than one activity in 12 months preceding disposition gain characterized and allocated among the activities on a reasonable basis 10 Classification of disposition gain 2 2 1 469 2T c and 2 c Substantially appreciated property rule prop is SA if its FMV 120 of its adjusted basis If SA property previously used in a nonpassive activity gain is NOT treated as passive unless property was used in a PA for either 20 of time it was held or during the entire 24 month period ending on disposition date 11 Disposition Question T sells office building which he held for 3 years During 12 months prior to sale T used building 7 months as rental and 5 months in his business Q How to treat T s gain 12 Disposition Question Anne acquires building on 1 1 97 and uses it until 3 31 08 in a business activity in which Anne materially participates On 4 1 08 Anne leases the building to Bob and on 12 31 09 sells it for 500 000 Adjusted basis 200 000 Q nature of disposition gain Q is the building substantially appreciated 13 Income recharacterization rules 2T f and 2 f SET 1 Rules preventing conversion of active business income into PAGI 1 2 3 SPA rule f 2 Rental of self developed property f 5 Self rented property rule f 6 self rental rule applies on property by property basis 14 Income recharacterization rules 2T f and 2 f SET 2 Rules preventing conversion of portfolio income into PAGI 1 2 3 Rental of non depreciable property f 8 Equity financed lending activities f 4 Passthrough entities licensing intangible property f 7 applies on property by property basis 15 Authority for income recharacterization rules Regulatory authority Congress gave to IRS at 469 l Preserve intent of 469 Leg history to protect underlying purpose of the passive loss provision i e preventing the sheltering of positive income sources through the use of tax losses derived from passive business activities Without such rules taxpayers would be encouraged to Change participation levels Convert investment activities to passive 16 SPA 2T f 2 SPA same definition as under 5T MP test If PAGI from all SPAs PAD from such activities net passive activity income treated as nonpassive activity income EX T has 3 SPAs and aggregate hours are 400 SPA MP test not met so passive If generate income treated as non passive IF t p met the SPA MP test the recharacterization rule would not apply would not be subject to 469