Capital Losses from Passive Activity in Real Estate

[clifmack]

I was a partner in a partnership that owned real estate and leased a substantial portion of the real estate to a business that I was a shareholder of. I changed jobs in 2020 and sold my partnership interest in the real estate partnership back to the partnership at cost. I held the interest for more than a year.

Notwithstanding the sale of my partnership interest at cost, I believe the basis of my partnership interests at the time of disposition will be substantially higher than the sale price (haven't got the K-1 yet). Upon information and belief, this is due to significant principal payments on debt, which resulted in a lot of phantom income, which substantially exceeded cash distributions and depreciation (when I bought into the partnership, the property had been depreciating the same asset since the 90s, so there wasn't much depreciation to go around). Given the above, I believe I there will be a significant capital loss from a tax perspective.

I'm having a hard time understanding how I can utilize the capital loss from this passive real estate activity (I was on the committee that managed the real estate but I don't think that's sufficient to establish "material participation").

If it is a capital loss, can it be used to offset ordinary income? If not, can it be used to offset capital gains from a non-passive activity (like selling stocks)? Is there a limitation on how much I can use in a given year?

Any guidance would be appreciated, I'm having trouble finding answers.

[LudwigVan_fan]

This is a complicated transaction.  When you say you sold your partnership interest back at "cost", what does that really mean?   Since there is a related party involved, what was the FMV of the partnership interest?

Also, you need to compute your basis in the partnership interest.  The starting point would be when you purchased the partnership interest, assumed debt, etc., etc.

Then each year, your basis would be adjusted based on your share of partnership items of income, losses, distribution, separately stated items of income and expenses.

Then, your adjusted basis would be subtracted from the "sales" price to determine gain/loss.

But, there are other items to be computed in the sale of a partnership interest.

Here is a starting point

https://www.irs.gov/publications/p541

Part of what you'll want to review is Disposition of Partner's Interest.

There is a lot to consider.  Also look at Effect of Partnership Liabilities, increase/decrease of basis, related party, etc.

Here is a link to some information regarding Passive Activity

https://www.irs.gov/publications/p925

This should help address any losses from Passive Activity in Real Estate.