Use of Suspended Passive Activity Losses in Year of Death

[John Thompson]

Hi!  I'm preparing the final return for a relative who passed in 2020.   She had suspended, unused PALs from a couple PTPs and an S Corp.   I understand these losses should flow to taxable income in her final 1040.  I also believe these losses are to be reduced to the extent of the step up on the investments.   My question is:  How do I make this happen in Turbo Tax?   I've entered the date of death and noted that the K-1s are final K-1s for those investments, but the losses stay suspended.   It seems like maybe there's a box somewhere that I need to check?   Or some form that needs additional input?   Whatever hints and help you can share are greatly appreciated!

[tagteam]

You can use suspended PALs to offset passive income on the final return but the excess PALs cannot be used since death is not considered to to be full disposition of the passive activity.

Carryovers of PALs to the estate is also not allowed.

However:

A deduction is allowed for the decedent's excess losses to the extent they exceed the excess of 1) the basis of the interest in the hands of the estate over 2) the decedent's adjusted basis [IRC Sec. 469(g)(2)]. In other words, a deduction for the excess losses is not allowed to the extent the estate receives a step-up in basis, as the step-up is granted instead of the loss deduction. If the excess losses exceed the basis step-up, the excess is deductible on the decedent's final return. If there is no step-up in basis for the passive activity at death, the losses are unsuspended and deductible in full on the decedent's final return.

See http://archives.cpajournal.com/1996/0796/depts/et.htm

[John Thompson]

Thanks for the helpful reply and the link!

[painthorsemom]

I have the same question as the original poster.  Where in the SOFTWARE do you tell TurboTax to take the suspended loss (to the extent that it exceeds step-up in basis)? 

Your answer does not respond to the original poster's question, which was "How do I make this happen in Turbo Tax?"   

Section A of Schedule K-1 shows the suspended loss carryover from prior years, but it does not permit an override of the loss allowed.  All or part of the loss should be allowable to the extent not exceeded by any step-up in basis, but where in the software is that accomplished?  It does not automatically appear, despite entering a date of death.

[Rick19744]

@painthorsemom TT is created for the vast majority of taxpayers.  There are some areas that need to be tweaked in order to get the software to arrive at the correct amount. 

I'm not aware of TT being able to handle this without some preparer intervention:

• You will need to determine the allowable suspended losses on the final return
  • Which as noted is the amount of suspended losses that exceeds the step-up
• You will then need to adjust the suspended losses in the form 8582 carryover worksheets in TT to reflect the allowable amount of suspended losses
• If for some reason this approach does not work, then I would recommend reflecting the allowable suspended losses on Schedule 1 line 24 code z.

I will ask @tagteam if he has a better solution / option within TT.
 

[tagteam]

Any suspended losses could be adjusted in Step-by-Step (the Interview), but would be limited to entering a figure in the K-1 section or Rentals section of the program (either of which may not be appropriate).

Beyond the aforementioned, the only other solution (as far as I have been able to determine) would be to do an override in Forms Mode (which would require one of the desktop versions of TurboTax as the online versions do not support Forms Mode).

[painthorsemom]

Thank you for your fast response and suggestions! 

I have found the problem (operator error, of course) and resolved it within the K-1 entries.  I had not matched the Rental real estate activity entries with the correct K-1 that was carrying forward the previous years' passive activity unallowed losses. 

To clarify, this corporation has two K-1's carried forward by TurboTax from year to year.  One is for Business - Box 1 activities, and one is for Rental real estate - Box 2 activities.   In 2021, I entered Business numbers via Easystep into the K-1 that carried forward the passive losses.  When I switched the K-1's so Rental activity was selected for the K-1 carrying the losses,  TurboTax automatically changed the prior years' passive activity unallowed losses to "allowed" in 2021 (the year of my husband's death).  Now, I can reduce the actual dollar amount allowed via override entry.

Your response also helped me to understand why I was having difficulty with overrides in general.  I have Premier desktop but wasn't paying close enough attention to the worksheets.  Black font does not care to be overriden.  Thank you, again.