Passive Activity Loss Rules: Strategies for Pass Throughs to - PowerPoint PPT Presentation

Presenting a live 110 ‐ minute teleconference with interactive Q&A Passive Activity Loss Rules: Strategies for Pass ‐ Throughs to Maximize Deductions Leveraging Latest Federal Guidance and Rulings to Establish Material Participation TUES DAY, FEBRUARY 28, 2012 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Today’s faculty features: Anne Bushman, Tax S , ervices Manager, McGladrey & Pullen , Washington, D.C. g , y , g , Peter Jorstad, Tax Manager, CJBS , Northbrook Michael Grace, Managing Director, Milbank Tweed Hadley & McCloy , Washington, D.C. Monica Tillett, Managing Director, WTAS LLC , Washington, D.C. For this program, attendees must listen to the audio over the telephone. Please refer to the instructions emailed to the registrant for the dial-in information. Attendees can still view the presentation slides online. If you have any questions, please contact Customer Service at1-800-926-7926 ext. 10 .

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Passive Activity Loss Rules: Strategies for Pass ‐ Throughs to Maximize f P Th h t M i i Deductions Seminar Feb. 28, 2012 Anne Bushman, McGladrey & Pullen Peter Jorstad, CJBS anne.bushman@ mcgladrey.com paj@ cjbs.com Michael Grace, Milbank Tweed Hadley & McCloy Monica Tillett, WTAS LLC mgrace@ milbank.com monica.tillett@ wtas.com

Today’s Program Overview Of Federal Passive Activity Loss Rules S lide 7 – S lide 13 [Anne Bushman] Passive Activity Concepts For Real Estate Professionals S lide 14 – S lide 20 [Anne Bushman, Pet er Jorst ad] Material Participation By LPs And LLC Members S lide 21 – S lide 30 [Michael Grace] S S tate Tax Issues Related To Passive Activity Losses R l d P i A i i S l d lide 31 – S l d lide 36 [Monica Tillet t ] Practical Issues From Compliance Work And Audits Practical Issues From Compliance Work And Audits S S lide 37 – S lide 37 S lide 54 lide 54 [Anne Bushman, Michael Grace, Pet er Jorst ad]

Anne Bushman, McGladrey & Pullen OVERVIEW OF FEDERAL OVERVIEW OF FEDERAL PASSIVE ACTIVITY LOSS RULES

Passive Activity Losses  Applicable to: - Individuals, trusts, estates, closely held C Corporations and personal service corporations  Limit deductibility of losses and credits   How to determine passive status How to determine passive status - Regular, continuous and substantial - Material participation 8

Material Participation Tests  Test one: Participation for more than 500 hours  Test two: Participation represents substantially all of the participation in the activity of all individuals  Test three: Participation for more than 100 hours, and at least as much as any other individual  Test four: The activity is a significant participation activity, and total participation in SPAs is more than 500 hours. - SPA: Trade or business activity in which you participated for SPA T d b i ti it i hi h ti i t d f more than 100 hours and in which you did not materially participate under any of the other material participation tests 9

Material Participation Tests (Cont.)  Test five: Materially participation in any five of the 10 immediately preceding tax years  Test six: Activity is a personal service activity, and you materially y p y, y y participated any three preceding tax years - PSA: Involves the performance of personal services or other trade or business in which capital is not a material p income-producing factor  Test seven: Based on facts and circumstances participation Test seven: Based on facts and circumstances, participation was regular, continuous and substantial (if activity was more than 100 hours). 10

Disallowed Losses And Credits  No current-year effect - Taxable income - Self-employment income  Allocated among taxpayer’s passive activities Allocated among taxpayer s passive activities  Carryforward indefinitely  Order of hurdles - B Basis i - At risk - Passive - Capital loss 11

Dispositions Of Passive Activities  Disallowed losses are deductible when: - Substantially all of activity is disposed - Disposition is a taxable event.  Disallowed credits - Continue to carry forward, unless taxpayer elects to increase property’s basis immediately before transfer by the increase property s basis immediately before transfer by the amount of credit that decreased property’s basis when placed in service 12

Return Compliance  Form 8582 13

Anne Bushman, McGladrey & Pullen A B h M Gl d & P ll Peter Jorstad, CJBS PASSIVE ACTIVITY CONCEPTS PASSIVE ACTIVITY CONCEPTS FOR REAL ESTATE PROFESSIONALS

Real Estate Activities  “Per se” passive activities p  $25,000 passive loss from active participation in rental real estate may offset against non-passive activities (subject to AGI limits) may offset against non passive activities (subject to AGI limits).  Exception for real estate professionals - S b t Substantially involved in real property trades or businesses ti ll i l d i l t t d b i - Must qualify as REP and still materially participate 15

Real Estate Professional  Qualifications - > ½ personal services are performed in trades or businesses by the taxpayer are in real property trades or businesses in which the taxpayer materially participated. - > 750 total hours of services are in real property trades or businesses in which taxpayer materially participated.  Cannot include time spent by spouse p y p  Real property trade or business: “Any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, q , , , p , g , g, or other brokerage trade or business” 16

Consequences Of Qualifying As REP  No longer “per se” passive, and fall back to normal passive activity rules  $25,000 limit does not apply.   Default rule treats each rental activity separately Default rule treats each rental activity separately. 17

El Electing i How to make election: Why or why not? Late election under Rev. Proc. 2011-34: Why or why not? Revocation Revocation 18

Sh Should The Late Election Be Made? ld Th L El i B M d ? Was an election ever made? - Yes: Well documented - Don’t know: No documentation - No: Well documented 19

Bailey v. Commissioner (“Bailey II”) Bailey v. Commissioner ( Bailey II ) T.C. Summary Opinion 2011 ‐ 22 Bailey v. Commissioner (“Bailey I”) Bailey v. Commissioner ( Bailey I ) T.C. Memo 2001 ‐ 296 Activity 1 Activity 1 358 hours 358 hours Activity 2 24 Activity 3 105 Activity 4 192 679 “Inn” 324 Short-term rental – not per se rental Total hours 1,003 20

Michael Grace, Milbank Tweed Hadley & McCloy MATERIAL PARTICIPATION BY LPs AND LLC MEMBERS

Limited Partner Material Participation  Issue: When is an individual a “limited partner,” for determining whether the individual materially participates?  Relevance: How many of the seven regulatory tests for material participation may the TP apply ? p p y pp y  Generally: To test material participation in trade or business activities?  Real estate: To test material participation in real property trades or businesses and in rental real estate activities (469(c)(7))? 22