Limitations on the Deduction of Allocated Losses

1
Limitations on the Deduction of Allocated Losses

• 3 Provisions limit the deductibility of
  partnership losses
• Sec 704(d) - partners may deduct losses only to
  the extent of their partnership basis
• Sec. 465 - partners may not deduct losses in
  excess of his/her at risk amount
• Sec. 469 - prohibits individuals and closely held
  corporations from deducting PALs in excess of PAI

2
Section 704(d)

• A partners deduction cannot exceed his/her total
  investment including share of debt.
• If allocated share of partnership losses exceeds
  his/her basis in the partnership interest -
• excess does not reduce basis, but is carried
  forward indefinitely and may be deducted when the
  partner has basis.
• For purposes of this limitation - any
  distributions made to the partner during the year
  are accounted for before the application of the
  basis limitation
• The allocation of loss is the last adjustment to
  basis to be applied.

3
At Risk Limitations

• Differs from Sec. 704(d) because most
  non-recourse debts are not considered At Risk.
• Partners are generally at risk for their
  investment in the partnership their portion of
  recourse debt or qualified non-recourse debt.
• Therefore, losses may be disallowed even though
  no Sec. 704(d) limitation exists.
• Qualified non-recourse debt - nonrecourse debt
  secured by real estate, which are obtained from a
  bank, SL, or other commercial lender. Excludes
  seller financed loans, and non-real estate non
  recourse loans

4
At Risk Limitations Continued

• Sec. 704(d) and Sec. 465 limitations are applied
  sequentially
• Only losses allowed by Sec. 704(d) can be limited
  by Sec. 465.
• Where basis and at risk are the same, losses will
  be disallowed under Sec. 704(d) only.
• Where basis and at risk differ, losses can be
  disallowed under both sections
• Sec. 465(e) discusses at risk recapture, when at
  risk basis is negative (excess distributions or
  debt reduction), amount taken into income is
  typically ordinary income rather than capital
  under Sec. 731

5
Sec 469 - Passive Activity Loss Limitations

• At Risk Rules and Sec. 704(d) rules are applied
  on a partnership by partnership basis.
• If a partner cannot take a loss because of the
  above limitations, the passive activity loss
  rules cannot be applied until the above
  limitations are lifted.
• General rule - passive activity losses are
  disallowed to the extent the passive activity
  losses exceed passive activity income.
• Net disallowed PALs are carried forward to tax
  years when PAI is available.
• Passive Activities are aggregated to determine
  the limitation.

6
Sec. 469 (continued)

• Passive Activity
• TP does not materially participate in the
  activity
• Partner is a limited partner
• Partnership is engaged in a rental activity (2
  exceptions, real estate professionals and general
  partners who actively participate but make less
  than 150,000)
• Passive losses disallowed must be allocated to
  all passive activities on a pro-rata basis. You
  cannot choose which passive activities you want
  to take the losses from, etc.
• Suspended passive losses can be taken in the year
  the passive activity is disposed by the taxpayer.