Suspended Loss

Jarrah holds a large suspended passive loss and points to an earlier, very profitable year in which he paid substantial tax. He asks his representative whether he can amend that earlier return to use the loss. The correct response is that:

1. A.He may amend it, because passive losses follow the same carryback rules as business lossesWrong. The two regimes are separate, and this one supplies no backward relief at all.
2. B.He may amend it, but only if the income reported in that earlier year was itself passiveWrong. The character of the earlier income is beside the point when no carryback exists.
3. C.He may not carry the loss back; a passive loss moves forward onlyCorrect. The suspended amount waits for future passive income and cannot reopen a closed year.
4. D.He may not carry it back, but he may deduct it currently against his salary insteadWrong. It swaps one unavailable route for another, since wages are nonpassive.

Why: Passive losses run forward only. There is no carryback, so amending a profitable earlier return to absorb a suspended passive loss is not available to him, however much tax that year produced. The suspended loss remains intact and available against passive income in future years. If Jarrah acquires an interest that allocates him passive income next year, the suspended loss becomes usable then.

An investor sells her entire interest in a passive DPP carrying suspended losses, but structures the sale as an installment sale, receiving payments and recognizing gain over several years rather than all at once. How does this affect the release of her suspended passive losses compared with a single, fully taxable cash sale?

1. A.It has no effect; the full amount of suspended losses is released in the year of sale regardless of whether the sale is structured as an installment saleWrong. An installment sale spreads the release of suspended losses over the years gain is recognized, rather than releasing them all at once.
2. B.The suspended losses are permanently forfeited because an installment sale does not qualify as a complete disposition for purposes of the passive-loss release ruleWrong. An installment sale still qualifies as a complete disposition; it simply spreads the release over the years gain is recognized rather than forfeiting the losses.
3. C.The suspended losses are released entirely in the final year the last installment payment is received, rather than spread across the payment yearsWrong. The release tracks the gain recognized each year, not a single release concentrated in the final payment year.
4. D.The suspended losses are released in proportion to the gain recognized each year under the installment method, rather than being freed all at once in the year of saleCorrect. The release of suspended losses follows the installment method's year-by-year gain recognition.

Why: The suspended losses are released in proportion to the gain recognized each year under the installment method, rather than being freed all at once in the year of sale.

An investor completely disposes of her entire interest in a real estate limited partnership to an unrelated buyer in a fully taxable cash sale. Going into the sale, she was carrying both suspended passive losses and suspended at-risk losses from the activity. What happens to each category of suspended loss as a result of the sale?

1. A.Both the suspended passive losses and the suspended at-risk losses become fully deductible, because a complete taxable disposition to an unrelated party frees all suspended losses from an activityWrong. The disposition rule that frees suspended losses on a full sale is specific to the passive-activity regime; it does not automatically extend to at-risk suspended losses.
2. B.The suspended at-risk losses become deductible because of the complete disposition, but the suspended passive losses remain suspended until she has passive income from another activityWrong. This reverses the two regimes -- the complete-disposition release belongs to the passive-loss rules, not the at-risk rules.
3. C.The suspended passive losses become deductible because of the complete disposition, but the suspended at-risk losses remain suspended unless the sale itself increases her at-risk amountCorrect. The passive-loss regime releases suspended losses on a complete taxable disposition; the at-risk regime releases losses only when the at-risk amount increases, which this sale does not automatically do.
4. D.Neither category is freed by the sale; both require the investor to remain in the activity and generate future income to absorb themWrong. This misstates the passive-loss rule, which specifically frees suspended losses upon a complete taxable disposition to an unrelated party.

Why: A fully taxable disposition to an unrelated party is the trigger that frees suspended passive losses. It is not, by itself, a trigger under the at-risk rules, which release suspended losses only when the amount at risk increases -- something the sale does not automatically do.

A taxpayer dies while holding an interest in a passive DPP with $40,000 of suspended passive losses. At death, the step-up in basis her heir receives on the interest, measured by the increase in the property's basis due to the step-up, is $25,000. How much, if any, of the $40,000 suspended loss is deductible on the decedent's final income tax return? (Figures are illustrative only.)

1. A.The full $40,000, since death is treated the same as a complete taxable disposition that frees all suspended losses regardless of any basis step-upWrong. Death is not treated identically to a complete taxable disposition; the basis step-up offsets part of the suspended loss.
2. B.$25,000, deductible on the final return, being the amount of the basis step-up itselfWrong. This inverts the calculation -- the step-up amount is what is absorbed, not what remains deductible.
3. C.$0, because a basis step-up at death always eliminates suspended passive losses entirely regardless of the amount of the step-upWrong. This overstates the offset; only the amount of the step-up is absorbed, and any excess suspended loss remains deductible.
4. D.$15,000, deductible on the final return, being the amount by which the suspended losses exceed the basis step-up the heir receivesCorrect. $40,000 of suspended losses minus the $25,000 basis step-up leaves $15,000 deductible on the final return.

Why: Only the portion of suspended losses exceeding the basis step-up the heir receives is deductible on the decedent's final return; the portion absorbed by the step-up is not separately deductible.