Deducting suspended losses on disposition of S stock.
Roger Johnson, a single taxpayer, has a $10,000 suspended loss from ABC Corp. and a $5,000 suspended loss from 123 Corp. carried over from the previous year. Both companies are S corporations.
On July 1, Roger sold all his ABC stock to an unrelated party, resulting in a $14,000 long-term capital gain. In addition, his ABC Schedule K-1 reflected a $1,500 ordinary loss and his 123 K-1 reported a $3,000 ordinary loss.
How does Roger treat these gains and losses?
If a taxpayer has unused passive losses due to the Sec. 469 limitation, they are "suspended" and carried forward to future years until the taxpayer generates net passive activity income or disposes of the particular activity. Use of a suspended loss from a passive activity requires that the disposition occur in a fully taxable transaction in which a taxpayer's entire interest in the activity is disposed of. Because the disposition rules allow the deduction of suspended losses from a particular activity, the taxpayer must allocate the excess passive loss from any particular year to specific passive activities and maintain a carryforward record of the suspended passive losses from each. Within the instructions for Form 8582, Passive Activity Loss Limitations, Worksheets 3 and 4 are available for this purpose. Alternatively, a taxpayer can maintain free-form schedules.
When a taxpayer sells an entire interest in a passive activity, both current and suspended losses generated by that activity (as well as any loss on the disposition) are applied first against net income or gain for the tax year from all passive activities. Any remaining unused loss is then treated as not from a passive activity, and fully deductible against other income.
The current year income or loss from the activity is combine with its prior year suspended Iosses and also with the gain or loss generated on disposition. If the net result is a loss, the various components are reported on the forms usually used (e.g., Schedule E or Schedule D). If the net result is an overall gain and the taxpayer has other passive activities, the income and losses are posted to Worksheet 1 or 2 of Form 8582. If the net result is an overall gain and there are no other passive activities, Form 8582 is not used and the gains and losses are reported on the schedules and forms otherwise used.
For Roger, the suspended losses from ABC (the activity disposed of) are first applied against any passive income or gain recognized during the year. The suspended and current year passive losses from ABC consume $11,500 of the gain on its disposition. The remaining $2,500 of gain is passive income and offsets cumulative losses from 123 to the extent of the gain.
The $14,000 long-term capital gain from the sale of ABC stock is reported on Schedule D, Form 1040. The interaction with the passive losses is not reflected on Schedule D.
Prop. Regs. Sec. 1.469-4(k) provides that the disposition of a "substantial part" of an activity (rather than the "entire interest," as required by the Code) may be treated as a complete disposition on which suspended losses are allowed. Unfortunately, the proposed regulation does not define or provide examples of what is considered to be the disposition of a "substantial part" of an activity.
The only additional guidance provided by the proposed regulation is that, to treat part of an activity as disposed of, the taxpayer must establish, with reasonable certainty, (1) the deductions and credits allocable to that part of the activity for the tax year and (2) the gross income and any other deductions and credits allocable to that part of the activity for the tax year.
Since Roger has an overall gain and also other passive activities, Form 8582 is required. The long-term capital gain is netted against the passive losses on Form 8582, but reported independently of the passive losses on Schedule D. Roger reports the $14,000 gain from the ABC stock on Schedule D and a $14,000 loss ($11,500 from ABC and $2,500 from 123) on Schedule E.
The $5,500 unused loss from 123 Corp. ($5,000 + $3,000 - $2,500) is suspended and carries over to the following year.
Editor's note: This case study has been adapted from PPC Tax Planning Guide - S Corporations, 8th Edition, by Andrew R. Biebl and Gregory B. McKeen, published by Practitioners Publishing Company, Fort Worth, Tex., 1994.
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|Author:||Ellentuck, Albert B.|
|Publication:||The Tax Adviser|
|Date:||Apr 1, 1995|
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