CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Income Tax Planning

1. CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMIncome Tax Planning Session 10Passive Activity Loss Rules

2. Session Details

3. Passive Activity loss rules • Why? • General Rule—Passive losses deductible against passive income (except PTPs) • Applies to— • Individuals, estates & trusts • Closely-held C corporations • Personal service corporations

4. Passive Activities • Trade or business activity without material participation (or) • All rental activities except: • Hotel/motels • Rental activities with significant services provided • Short-term rentals of property (DVDs, tuxedos, etc.) • Material participation in real property trades or businesses • Active participation in rental real estate

5. Material Participation • Meets one of seven tests under regulations • 500 hours per year of participation—most common test • 100 hours and no one participates more • Facts and circumstances test • Regular, continuous, and substantial involvement • What is taxpayer’s knowledge, background, experience?

6. PAL Exceptions/Opportunities Active Participation in Rental Real Estate • Requires “bona fide” involvement • $25,000 of losses allowed annually • $100,000 to $150,000 AGI phaseout of losses • 10% or greater ownership interest in the activity • Not a limited partnership interest • Not available if MFS, unless lived apart for entire year

7. PAL Exceptions/Opportunities Historic Rehabilitation Programs • $25,000 deduction-equivalent tax credit • May offset tax due on up to $25,000 of other income • $200,000 to $250,000 AGI phaseout

8. PAL Exceptions/Opportunities Low-Income Housing Activity • $25,000 deduction-equivalent tax credit • May offset tax due on up to $25,000 of other income • $200,000 to $250,000 AGI phaseout if property placed in service prior to 1990 • No AGI limit if property placed in service after 1989

9. Material Participation in Real Estate Losses deductible if • more than 50% of hours are devoted to real property trades or businesses with material participation • more than 750 hours are in real property trades or businesses with material participation

10. Oil & Gas Working Interest Ownership of Oil and Gas Working Interest • Losses are deemed to be not passive. • The form of ownership cannot limit taxpayer’s personal liability. • No participation is required. • Losses are deductible without limit and without respect to taxpayer’s AGI.

11. Requirements to Qualify for Special Tax Benefits Closely Held C Corporation • If not a personal service corporation, passive losses may be used to offset active income, but not portfolio income. Qualified Nonrecourse Financing • secured by the real property • no one is personally liable • not convertible into equity • provided either by: • an unrelated entity in the business of lending money, or • a related person on commercially reasonable terms

12. Publicly Traded Partnerships • Losses are not deductible against other passive income. • Losses are held in suspense until SAME activity generates income. • Income cannot be offset by passive losses arising from any other source.

13. Disposition Rules Sale/Exchange • All losses are “freed up” and deductible in full against other income if disposition of “substantially all.” Death • Losses are deductible to the extent that the losses exceed step-up in basis of activity. Gift • Losses are added to basis of gifted activity.

14. Review Question 1 The passive activity loss rules apply to • personal service corporations only. • closely held C corporations only. • individuals only. • personal service corporations, closely held C corporations, and individuals.

15. Review Question 2 Which one of the following is a characteristic of the historic rehabilitation tax credit? • The credit may be used to offset up to $25,000 in income tax. • The credit may be used to offset the tax on up to $25,000 in income. • The credit is phased out on adjusted gross income between $100,000 and $150,000. • The credit is phased out on taxable income between $200,000 and $250,000.

16. Review Question 3 Your client, Marian Powers, has substantial unused passive losses from a nonpublicly traded limited partnership. She would like to find an investment that would allow her to utilize her passive losses. Which one of the following is the most appropriate investment for Marian? • a master limited partnership generating income • certificates of deposit generating portfolio income • a publicly traded limited partnership generating income • a nonpublicly traded partnership generating income, in which Marian will not materially participate

17. Review Question 4 Sally Franklin has AGI of $300,000. In addition, she currently has passive income of $150,000 and passive losses of $175,000; $150,000 of which she uses to offset the passive income and $25,000 of which is subject to disallowance. Which one of the following activities, if any, has the greatest potential for reducing Sally’s tax liability? • investing in “active participation” rental real estate that is producing a loss • investing in a low income housing activity placed in service after 1989 that is producing deduction-equivalent credits • investing in a limited partnership involved in a historic rehabilitation project that is producing passive losses and credits • investing in an oil and gas limited partnership that is generating losses

18. Review Question 5 Paul Hall has the following items from the current year: What is the total amount, if any, of passive losses that may be deducted during the current year? • $0 • $13,000 • $23,000 • $29,000 • $30,000

19. CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMIncome Tax Planning Session 10End of Slides