Sched E Partnership and S Corp Inc/Loss Flow Through to 1040, Other Inc/Loss, via Sched 1

[Curious One]

In both 2018 and 2019 I see that LP losses on Schedule E have found their way to the 1040 on lines 6 and 7a, respectively, as a deduction to other income sources via Schedule 1.  In 2018, it was costly but not too significant.  In 2019, it has become more so and income that might have been shifted to be recognized in such years (think IRA Roth conversions), but wasn't may now become taxable in subsequent years.  I'm confused about a few things.  First, I thought that passive income/losses were treated wholly separate from earned income or portfolio income.  If so, then why is TT showing an offset of these losses against other income sources?  Second, in light of this apparent tax benefit, are there any steps I can take at this time to take advantage of these losses?  For example, 2019 IRA Roth conversion post 12/31/19?  Other ideas?  Third, is there a way to anticipate the magnitude of the losses in future years to allow for most appropriate tax planning going forward?  Finally, if not used/usable in current year, even if showing above the line on 1040, can such losses be used in future years against passive gains from disposition, etc.?  That is, is there a carryforward aspect to such losses, as was expected, or has something changed that I missed entirely?  Alternatively, while unlikely, is there a way to carry forward itemized deductions?  Is there an easy way to compare loss carryforwards between 2018 and 2019 to see how the carryforward may have been treated?  

[tagteam]

Your post presents a threshold question:

Did you, by any chance, indicate in the program that you materially participated in the LP? 

[Curious One]

Good question, but no.  I didn't make that election. 

[tagteam]

I presume you entered the information from a K-1 you received from the LP.

Can you delineate what appeared on the K-1? Specifically, was the loss related to an interest the LP had in real estate? If so, note that there is a special $25,000 allowance for real estate losses that can offset other income (beyond passive income) with active participation (subject to income limits on your return).

[Curious One]

A bit more background.  In both 18 and 19, there were LTCGs from passive investments (without active role), the majority of which were real estate LLCs.  These were offset against Sched D loss carryforwards.  In 2019, the LTCGs were smaller than the losses that were allowed as negative income.  2019 numbers are larger than 2019 1231 gains or 2019 NOLs.  2018 NOLs are larger than 2018 negative income.  Seems to suggest relationship between sum of current year loss and carryforward loss, on the one hand, and current year negative income, on the other.  2018 1231 gains are roughly equivalent to 2018 LTCGs. 

If losses were passive, are they converted to active if capital gain loss carryforward is used to satisfy any tax liability otherwise resulting from LTCGs?  

How are the LTCGs and negative income numbers determined?  If taken as negative income in year 1, are there any circumstances where they can be taken again in later years?  In either case, is there an easy and effective way to both anticipate magnitude of future negative income and likelihood that it will be applied to a given tax year's return?  

Some questions repeat from original post.  Other questions from original post remain.  Please read in totality for most complete response possible.  Reference to sources helpful, if available.  

[Anonymous]

A bit more background.  In both 18 and 19, there were LTCGs from passive investments (without active role), the majority of which were real estate LLCs. These were offset against Sched D loss carryforwards.  In 2019.

if the LTCG were reported on line 9a they were not passive (they're portfolio) so they would have no effect on passive losses allowed.

if the LTCG was reported on line 11 it would show up in a supplemental schedule. this would likely be passive and would offset passive losses.  the way this gets reported is the allowable passive losses flow to schedule E while the passive capital gains flow to schedule D and would be available to offset capital losses'

LTCGs were smaller than the losses that were allowed as negative income.  2019 numbers are larger than 2019 1231 gains or 2019 NOLs. 

1231 gains and losses first flow to form 4797.  if there is an over gain (after any previous unrecaptured 1231 losses) the gain flows to schedule D.   if modified adjusted gross income is below $150,000 for most taxpayers there is a special loss allowance for real estate investments - up to $25,000

2018 NOLs are larger than 2018 negative income.  Seems to suggest relationship between sum of current year loss and carryforward loss, on the one hand, and current year negative income, on the other.  2018 1231 gains are roughly equivalent to 2018 LTCGs.  1231 gains and LTCGs are each items of income 

If losses were passive, are they converted to active if capital gain loss carryforward is used to satisfy any tax liability otherwise resulting from LTCGs?  SEE my remarks above. Passive capital gains allow passive losses but do not convert them to active.  it's your participation in the activity that determines whether Real Estate losses are passive or active.  

The exception is that disposal of the activity if a fully taxable transaction releases any suspended losses 

How are the LTCGs and negative income numbers determined?  If taken as negative income in year 1, are there any circumstances where they can be taken again in later years?  In either case, is there an easy and effective way to both anticipate magnitude of future negative income and likelihood that it will be applied to a given tax year's return?  

capital gains and losses are netted. if there is a net capital loss up to $3,000 is allowed each year any excess is carried over to the following year.  then there is all the other income and losses on your return through adjusted gross income .  should business losses exceed net non-business income you have a nol. if there is an NOL the $3,000 capital loss if present is not used but goes back to being part of the capital loss carryover.

TT does not compute NOL.  you need to use form 1045 schedule A

https://www.irs.gov/pub/irs-pdf/f1045.pdf

'

[Curious One]

Questions still remain:

- if merely a passive investor, is the 25k offset to ordinary income available?  if so, is it captured in TT or do I have to do something on my own to adjust the return to reflect this benefit?

- are there any options at this point in 2020 to income shift backwards into 2019 to take advantage of the released PALs tax benefit?

- is there a way to look at capital accounts and current year disposals to guestimate potential PAL releases resulting from such activity?

- still unclear about released PALS relative to realized capital gains from disposal.  would have thought PALs would first be applied to any passive investment capital gains before taken as negative income above the line.  by corollary, would have thought passive investment capital gains would be offset by PALs before being offset by any capital loss carryforwards arising from capital market or other non-passive investments.  

Thanks for your continued feedback.  

[Anonymous · Accepted solution]

Questions still remain:

- if merely a passive investor, is the 25k offset to ordinary income available? if so, is it captured in TT or do I have to do something on my own to adjust the return to reflect this benefit?

TT does handle the situation you describe. the $25,000 is only available for passive real estate activities. TP must actively participate and have a modified adjusted gross income of less than $150,000.  passive losses (after taking into account any passive losses limited by basis or at risk limits) first flow to form 8582 and then the calculations are made on that form and allowable losses flow to schedule 1

- are there any options at this point in 2020 to income shift backwards into 2019 to take advantage of the released PALs tax benefit?

would think not since any 2020 activity would be reported on 2020 return.  there is an exception should you have an NOL but then the CARES Act requires a 5 year carryback of NOL and then carryforward. 

- is there a way to look at capital accounts and current year disposals to guestimate potential PAL releases resulting from such activity?

if you dispose of an activity in 2020, the PAL suspended losses are allowed (per IRS these are reported in the passive loss column (g) on schedule E while the current year loss or income gets reported as non-passive in column i or k.  these losses do not flow to form 8582 

- still unclear about released PALS relative to realized capital gains from disposal. would have thought PALs would first be applied to any passive investment capital gains before taken as negative income above the line. by corollary, would have thought passive investment capital gains would be offset by PALs before being offset by any capital loss carryforwards arising from capital market or other non-passive investments.

capital gains from the disposal of the underlying partnership assets are reported on lines 8 or 9a and are not passive but are portfolio income. thus the capital gains flow to schedule d and the ordinary losses flow to schedule E.   passive capital gains also retain their character even if there are passive losses. they are supposed to be reported on line 11i line 3 or 4

so if you have a current year $500,000 passive capital gain and passive ordinary loss of $500,000 and a $100,000 PAL carryover. if no disposal these items flow to form 8582. the $500,000 gain flows to 8949 which flows to schedule D and an allowed $500,000 current year PAL  that flows to schedule E.  so you end up with a $100,000 PAL carryover.  full disposal the 8582 disappears.  

if you had a $200,000 passive capital gain and PAL's as described above. only $200,000 of ordinary PALS would be allowed unless complete disposal.  if the capital gain wasn't passive and there was no disposal the capital gain would be reported and PALs would be limited. 

[Curious One]

Have some more work to do to get my arms fully around all of this, but that last response was very helpful.  Thanks much for the input.