Passive Income/Loss

[ralphv]

Have a new client that is being audited (2006). Client & spouse had w-2 income of 155k, a rental loss of 87,977 and a gain from the sale of a rental property of 85,383. IRS wants to eliminate the rental loss of 87k because of income limitations and tax the gain of 85k. On the return, the two figures flow to form 8582 and allows a rental loss of $85,383. I believe that you can offset passive losses with passive gains and that the return is correct. Am I missing anything here?

[jainen]

>>you can offset passive losses with passive gains<<

True enough, but apparently these taxpayers don't have any passive income. By the way, why are they changing tax preparers in the middle of this?

[michaelmars]

was the gain on sale the same property that generated the rental loss?

[ralphv]

>>you can offset passive losses with passive gains<<

True enough, but apparently these taxpayers don't have any passive income. By the way, why are they changing tax preparers in the middle of this?

Isn't the gain on the sale of the rental prop passive?

[TAXBILLY]

Is there more than one rental property with suspended losses?

taxbilly

[ralphv]

Is there more than one rental property with suspended losses?

taxbilly

There were 4 properties, one of which was sold.

[TAXBILLY]

Was any of the rental loss specific to this property that was sold?

taxbilly

[ralphv]

Was any of the rental loss specific to this property that was sold?

taxbilly

Yes, some of the loss was specific to the property sold.

[TAXBILLY]

The loss specific to the property sold would be the only loss you could use.

taxbilly

[Eeyore1954]

Shouldn't they first have been allowed to offset all losses (including suspended) on the property that was disposed of and then any excess gains should go to allow losses on the other properties.

I would say the IRS is incorrect unless the IRS is saying the property that was disposed of was not a passive property or some other facts that we do not see here.

[jainen]

>>the IRS is saying the property that was disposed of was not a passive property<<

I would guess the IRS position is that capital gains do not offset passive losses. Of course, the entire disposition of a passive activity will release suspended losses from that specific property, but that doesn't appear to me to be what happened.

By the way, why are they changing tax preparers in the middle of this?

[Eeyore1954]

>>the IRS is saying the property that was disposed of was not a passive property<<

I would guess the IRS position is that capital gains do not offset passive losses. Of course, the entire disposition of a passive activity will release suspended losses from that specific property, but that doesn't appear to me to be what happened.

By the way, why are they changing tax preparers in the middle of this?

But upon what basis are they saying it is not a passive property. Usually most rentals are automatically passive. Was it a vacation home with personal use of more than 14 days?

[Maribeth]

By definition, rental property disposed of in the current year is NOT passive. Suspended losses attached to that property are released in the year of disposition. Other passive activities and allowable losses are determined separately.

Maribeth

[jainen]

>>Usually most rentals are automatically passive.<<

Oh yes, of course. The rental ACTIVITY is passive. But the capital GAIN is not passive income, so it can not offset passive losses.

By the way, why are they changing tax preparers in the middle of this?

[ralphv]

Ok,now that I have ALL of the facts, let me share:

TP had 4 rental properties and sold one of them using installment method (6252)the previous year (2005). In '06 (year being audited)the balance was paid off and the majority of the gain was realized (85,383). These 4 properties were all rentals and had been for some time. Up to this point there were no suspended losses. The 3 remaining properties reported a RENTAL LOSS of 87,977. On the return, the loss of 87,977 is limited to the gain of 85,383 and both amounts flow to form 1040, lines 13 and 17. The IRS is disallowing the 85,383 loss and thus only considering the gain, resulting in a deficiency of around 50K when incl. penalties, interest etc.

I would like to thank all of you that chimed in. I know your time is precious and limited. This field is very complicated and things can be interpreted differently and sometimes incorrectly. I am of the belief that if you are not 100% certain, you ask and dig. That is why I posted the question.

[Eeyore1954]

>>Usually most rentals are automatically passive.<<

Oh yes, of course. The rental ACTIVITY is passive. But the capital GAIN is not passive income, so it can not offset passive losses.

By the way, why are they changing tax preparers in the middle of this?

But I am "certain or was certain" the gain on a sale of a passive activity is allowed to offset passive losses from other properties.

In an installment sale current and suspended losses may only be deducted in the same ratio as the gain reported. If the remaining proceeds were paid in 2006 I do not see why that gain should not go onto the worksheets on form 8582 and allow other losses. It wasn't a sale to a related party was it.

[Eeyore1954]

Income from the sale or other disposition of passive activity is generally passive income if the activity was a passive activity in the year of sale (Reg. § 1.469-2T©(2)(i)). Similarly, income from the sale or property used in a passive activity is passive income. If there is overall net income on a disposition (gain on the sale exceeds the current and prior years losses), income and losses should both be reflected on the same line of Worksheet 1, 2 or 3 of Form 8582.

From http://www.irs.gov/businesses/small/article/0,,id=146336,00.html

[ralphv]

Yes, the property sold in '05 (installment sale)was a rental property. I inserted all of the values from tp into ATX for tax year '06 and the software routes the gain from the sale to form 8582. It combines it there with all rental losses from '06. The rental loss was $87977 and the gain from the sale was $85383. The loss on form 8582 is limited to the amount of the gain (85,383).

[ralphv]

Income from the sale or other disposition of passive activity is generally passive income if the activity was a passive activity in the year of sale (Reg. § 1.469-2T©(2)(i)). Similarly, income from the sale or property used in a passive activity is passive income. If there is overall net income on a disposition (gain on the sale exceeds the current and prior years losses), income and losses should both be reflected on the same line of Worksheet 1, 2 or 3 of Form 8582.

From http://www.irs.gov/businesses/small/article/0,,id=146336,00.html

Attached is right out or the IRS website:

Installment Sale

If the taxpayer sells a passive activity on the installment basis, current and suspended losses may only be deducted in the same ratio as the gain reported. If there is excess gain, that gain is passive income under Reg. § 1.469-2T©(2) and will permit deductibility of additional losses to the extent of the gain.

[Eeyore1954]

Unless there are some missing facts I say the gain should be allowed to offset passive losses now that the entire balance has been paid.

[ralphv]

Unless there are some missing facts I say the gain should be allowed to offset passive losses now that the entire balance has been paid.

Thank all of you for your replies and support. I am taking the same approach and will report after all is said and done.

[the boss]

This case has finally reached a climax. After all of this time......with the help of a tax attorney and days from going to tax court, IRS finally gave in. What a learning experience this was.

[kcjenkins]

Glad you fought the good fight and won, It's sad that often the t/p will just give up and pay up even though they are in the right, because the IRS can cause them to have to spend a lot of money to fight the issue. Your client has enough funds to make it worth the fight, but often t/p's don't. The IRS knows that, and sometimes abuses the system just because they can bully with an unlimited budget for fighting the case.