Does TTax account correctly for section 1231 gain?

[t_taxslave1]

I saw several posts wondering why the tax liability DECREASED when a Section 1231 GAIN is present, but none ended with a clear answer. In my case, I have a partnership K-1 with:

- suspended losses from prior year (2021)

- S.1231 gain for tax year (2022), smaller than the prior suspended losses

and I also have capital losses carried forward from prior year.

TTax does the following (checked multiple times):

• Form 4797 shows the 1231 (positive) gain and hence the carried-over capital losses are offset by this gain on Sched D
• Form 8582 also shows the 1231 gain offsetting suspended passive losses for this partnership
• Sched E and Sched 1 show the gain as negative, therefore reducing the AGI and taxable income (hence reducing the tax liability as compared to no 1231 gain) – which is counter-intuitive to me, as well as to others who posted on this dilemma...

I think that the latter is done to compensate for the double offset of losses: once of prior capital losses and again of prior passive losses. I realize 1231 gains can offset capital losses, but why does the process not stop there? Rather than also offsetting passive losses and then reducing ordinary income to compensate for this second offset?

Can anyone help? Thx in advance.

[tagteam]

I am not sure if the answer below is directly responsive to the question you want answered but here goes:

Section 1231 net gains are treated as capital gains provided the assets are held for more than one year. Capital losses can be used to offset capital gains and up to $3,000 of net capital losses can be used to offset all other income.

However, losses from passive activities cannot be used to offset capital gains nor other types of income. Such losses are suspended and can only be used to offset passive income per Section 469 (until sold to an unrelated third party in a fully taxable transaction).

[t_taxslave1]

Thank you, but indeed not relevant to my TurboTax question which is; Why does the program use S.1231 GAIN to offset both capital losses and passive suspended losses, and then compensates the double offsets by reducing income by the amount of 1231 gain (instead of only offsetting capital losses).

[Mike9241]

I would agree something seems wrong with TT calc. 

your capital loss carryover is being reduced by the 1231 gain and then you get a $3,000 capital loss which is proper. but then TT is also treating the 1231 gain as passive income reducing your passive loss c/o which seems its double counting.

example

10000 1231 gain

12000 passive loss carryover

30000 capital loss carryover

so it would seem the c/o's in total should be 32000 further reduced by the 3000 capital loss allowed so you should end up with 

12000 passive loss carryover and 17000 capital loss carryover but TT is coming up with

2000 passive loss carryover and 17000 capital loss carryover

[t_taxslave1]

You are correct. However, the double counting of loss offsets (once of capital loss, then also of passive loss) is being "compensated" (my term) by reducing my taxable income. TT does this by changing the sign of the GAIN to NEGATIVE on the K-1 worksheet, so Schedule E shows the GAIN as a NEGATIVE number, thus REDUCING the AGI. This causes my tax liability to go DOWN as a result of the 1231 GAIN. And the IRS has a problem with that...:-)

[Mike9241]

checked again this morning. Now using my example. (desktop) i end up with $12K PAL C/O and $17K capital loss c/o which are proper.