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Well, students, in this video, we
will discuss the final learning objective--
number six-- for chapter 20, regarding loss limitations
with partnerships and partners.
Well, in previous videos, we talked
about income distribution and loss distribution,
and we pretty much only discussed the income part.
Now, here, if a partnership has distributed
some kind of loss, which partners can deduct
on their personal income tax returns,
then they are subject to some kind of loss limitations.
Partnership losses generate current tax benefits
when partners can deduct them against other sources
of taxable income.
Ordinary losses from partnerships
are deductible against any type of taxable income,
after they clear three separate hurdles, as follows.
Hurdle number one; tax-basis limitation.
Partners may not utilize partnership losses
in excess of their investment of their outside basis
in their partnership interests.
Any losses allocated in excess of their basis
must be suspended and carried forward, indefinitely,
until they have sufficient basis to utilize the losses.
Partners may create additional tax basis, in the future,
by making capital contributions, guaranteeing partnerships' debt
and helping their partnerships to become profitable.
When partners sell or dispose of their interest,
any suspended losses are lost forever.
So this-- you may want to make a note of this,
in advising your clients-- that, if they
are subject to tax basis in limitation,
make sure-- if they have some kind of losses carried over,
do not sell or dispose their interest;
otherwise, these losses is lost forever.
See example 20-24, on page 20-30.
OK?
Hurdle number two; at-risk limitation.
The at-risk hurdle or limitation is
more restrictive than the tax-basis limitation,
because it excludes a type of debt normally
including a partner's taxable basis.
The at-risk rules in Section 465 limited the ability of partners
to use nonrecourse debt as a means of creating
tax basis to use losses from tax shelters--
partnerships-- expressly designed
to generate losses for the partnership.
These at-risk rules limit partners' losses
to their amount at risk in partnership--
their at-risk amount.
A partner's at-risk amount equals his or her tax basis,
except that the partner's share of certain nonrecourse
debts such as real-estate mortgages
from commercial lenders that are unrelated to borrowers.
These are not included in the at-risk amount.
This type of debt is called "qualified nonrecourse
financing."
In addition to qualified nonrecourse financing,
partners are considered to be at risk to the extent of cash
and the tax basis of property contributed to the partnership.
Further, partners are at risk for
any partnership-recourse debt allocated to them.
Partners, they apply the at-risk limitation
after the tax-basis limitation.
So which means you need to go through hurdle one,
and then you go through the hurdle
number two-- at-risk limitation.
Any partnership losses that would otherwise
have been allowed under the tax-basis limitation
are further limited to extending the sea of partners at-risk
amount.
Losses limited under the at-risk rules
are carried forward, indefinitely,
until a partner generates additional at-risk amounts
to utilize the losses, or until they
are applied to reduce any gains from selling the partnership
interests.
So this one, actually, you can use their losses.
Please see example 20-25, on page 20-30 and 31.
Final hurdle; passive activity loss limitations.
Congress introduced the passive activity loss--
or, usually, we call them PAL-- "pal," OK?
--rules, in 1986, to be applied after the tax-basis
and at-risk limitations.
Therefore, partners may have to overcome
three separate hurdles, before reporting partnership
ordinary losses on their returns.
In a nutshell, the passive activity loss rules
limit the ability of partners in rent,
rental, real estate partnerships,
and other partnerships they don't actively manage.
Which means they own these partnerships
as passive activities.
That will prevent them-- these passive partners--
from using the ordinary loss-- or losses--
from these activities, to reduce their other sources
of taxable income.
And how do we define a passive activity?
According to the IRS, a passive activity
is any activity which involves the conduct of a business
or trade and in where the taxpayer does not materially
participate.
Participants in a rental activity-- including
rental real estate-- and limited partners without managing
rights are passive participants.
All other activities are passive unless the partner's
involvement in the activity is regular, continuous,
and substantial.
Regulation provides seven separate tasks
for material participation.
An individual other than a limited partner
is a material participant in an activity by meeting one--
OK, remember-- meeting one of the seven tests,
in this exhibit.
Number one, partners must participate greater than 500
hours in the activity of the partnership.
Number two, activity is substantially
participated by individuals of such activity.
Number three, participates greater than 100 hours
and no less than other individual partners'
participation.
Number five, materially participates
in an activity out of any five of the preceding ten tax years.
Number six, personal services in the health, law, accounting,
architecture, with the material participation for any three
proceeding years.
So, for the people in these fields of profession,
they only need three years of participation,
to be considered to actively participate.
Number seven, the last one, participate
on a regular, continuous, and substantial basis
during the year.
For income and loss, we actually need
to sort them into different income and loss baskets.
Under the passive activity loss rules,
each item of partner's income or loss, from all sources,
for the year, is placed in one of the three
categories-- or "baskets."
Losses from the passive basket are not
allowed to offset income from other baskets, which
means if it's passive loss, only can use them
of to against any passive income.
The three baskets are number one,
called passive income/loss.
The other ones are portfolio income/loss
or active income/loss.
So active income/loss pretty much uses
the regular income-- or ordinary income/loss.
Portfolio will be talking about the capital gains laws,
or any kind of investment, or some kind of contract,
such as annuity or royalties.
Number one, passive activity income/loss.
Income or loss from an activity, including partnerships,
in which the taxpayer is not a material participant.
Number two-- before we go on to number two,
we already talked about-- or we considered-- passive activity,
as defined by the IRS.
Number two, portfolio income.
Income from investments, like gains and loss
in stock, and bonds, dividends, and interest, annuities,
and royalties.
And finally, active business income.
Income from sources, including partnership,
in which the taxpayer is a material participant.
For individuals, this includes salaries and self-employment
income.
The importance of separating such different categories--
or different baskets-- of income is
because the impact of segregating a partner's
income in these baskets is to limit--
will limit his or her ability to apply passive activity
loss against any other income, in the other two baskets.
For example, passive loss cannot be counted against
the portfolio or active income.
And in fact, passive activity losses
are suspended and remain in the passive income/loss
basket until a taxpayer generates
current-year passive income, either from passive activity
producing the loss, or from some other passive activity,
or until the taxpayer sells the activity that
generated the passive loss.
In addition to reporting gain and loss
from a sale of property, the taxpayer
is allowed to deduct suspended passive loss as ordinary loss.
For this one, you will need to see examples 20-26
and 27, on pages 20-33 and 34.
For this segment, it concludes the learning objective
for number six, for this chapter.
In this chapter, we discussed the loss limitations
where-- how much loss can partners take, and also
whether-- the characters of different kinds of income
and losses.
Thank you.