Suspended passive losses from Rental Property A and current passive losses from Rental Property A and Passive K-1 Activity B are not being released with the sale of Rental Property C

[nomad6]

Hello,

I am new to using TurboTax, but I am trying to produce a return in the year of selling a rental real estate property for a gain. I have these current and suspended losses: 

- Rental Property A -  current losses and suspended losses

- Rental Property B (sold) - current losses and suspended losses

- Schedule K-1 - current net passive operating losses

It's my understanding from all my research that all of these losses should be unsuspended given that Rental Property B was sold at a gain in the same year. The properties are in separate Schedule E columns (they are not grouped). 

But nothing I do from Turbo Tax Mac seems to be able to release the full amount of the losses for Rental Property A or for Schedule K-1.

Can anyone help me figure out what is going on?

[Mike9241 · Accepted solution]

assuming there was a gain on disposal, passive losses from real estate would be allowed to the extent of the gain. if the k-1 is not a real estate activity, it remains subject to its PAL rules.

example

property A sold for a taxable gain of $100,000 

property A has current and suspended losses of $60,000

those are allowed in full leaving $40,000

property B has current and suspended losses of $75,000

$40,000 will be allowed and $35,000 will remain suspended (if your AGI is over $150,000 no additional special allowance for real estate activities with  active participation)

look at form 8582

yuo provided no numbers and we have no access to your return. 

[nomad6]

The K-1 is an LLC that owns a townhouse complex. I'm not sure if I'm entering the "pretend" K-1 correctly and I don't have the actual K-1 yet as this is a test for 2024 using the 2023 software, but, I know the operating losses are in Box 1 for the K-1 1065. 

 But, when I fill out a 4797 for Property C, it is not releasing the suspended losses from Property A, either. It's releasing a very tiny percentage on the 8582 form, at the bottom of the form, but both Property A and the K-1, but the vast majority of the losses for both are showing as Unallowed. Am I doing something wrong in the software? 

And, given that this would be a K-1 1065 that the sponsor told me is an "equity kicker" for a loan I'm considering making to the LLC, am I somehow entering the K-1 wrong? No matter what I do, it seems to show up as passive losses, though the sponsor tells me it should be net operating losses, and I'm not a managing member. I

It doesn't seem like it should be this confusing/complicated, but I can't seem to generate a tax return that flows such that either the suspended passive loss from Property A or the current year Box 1 losses from the K-1 are offsetting any of the capital gain from selling the real estate using 4797. 

Many thanks for any insight! I'm happy to provide an example of how I filled it out... It looks like I could attach a document or an image to this thread. Is that how people normally share it? 

Rought numbers

- 20,000 W2 income

- 250,000 from selling the investment real estate

- 150,000 from the Box 1 of K-1

- 20,000 of suspended passive losses from Property A (not sold) 

- 2,000 of current passive losses from Property A

- 15,000 of suspended passive losses from Property C (sold real estate in same year)

- 1,000 of current passive losses from Property C

- No other income 

thank you!

[Mike9241]

for the rental real estate activities is active participation checked or is material participation checked or neither?

are the rental real estate activities aggregated/grouped as 1 activity?

is  A rented to friends or relatives at below fair rental value?

active participation defined

You may be treated as actively participating if, for example, you participated in making management
decisions or arranged for others to provide services (such as repairs) in a significant and bona fide sense.
Management decisions that may count as active participation include:
• Approving new tenants,
• Deciding on rental terms,
• Approving capital or repair expenditures, and
• Other similar decisions.

material participation defined

 You materially participated for the tax year in an activity if you satisfy at least one of the following tests.
1. You participated in the activity for more than 500 hours.
2. Your participation in the activity for the tax year was substantially all of the participation in the activity of all
individuals (including individuals who didn’t own any interest in the activity) for the year.
3. You participated in the activity for more than 100 hours during the tax year, and you participated at least as
much as any other individual (including individuals who didn’t own any interest in the activity) for the year.
4. The activity is a significant participation activity for the tax year, and you participated in all significant
participation activities during the year for more than 500 hours. A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you didn’t
materially participate under any of the material participation tests (other than this fourth test).
5. You materially participated in the activity (other than by meeting this fifth test) for any 5 (whether or not
consecutive) of the 10 immediately preceding tax years.
6. The activity is a personal service activity in which you materially participated for any 3 (whether or not
consecutive) preceding tax years.  An activity is a personal service activity if it involves the performance of personal services in the fields of health, law, engineering, architecture, accounting, actuarial
science, performing arts, consulting, or in any other trade or business in which capital isn’t a material
income-producing factor.
7. Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and
substantial basis during the tax year. You didn’t materially participate in the activity under this seventh test, however, if you participated in the activity for 100 hours or less during the tax year. Your participation in managing the activity doesn’t count in determining whether you materially participated under this test if:
a. Any person (except you) received compensation for performing services in the management of the activity, or
b. Any individual spent more hours during the tax year performing services in the management of the activity
than you did (regardless of whether the individual was compensated for the management services)

***********************************

for the k-1 what boxes did you check for the following:

1) what type of partner?

2) for the loss on line 1 what type of activity?

3) is material participation unchecked?  (see above for definition) 

*****************************

finally, for the 8582 tell us the amounts showing up and the related line number. round to thousands. indicate loss with a minus sign.

*****************************************************

[nomad6]

Rental real estate: I initially had checked Active Participation for all three properties (the two still held and the one sold), but I also unchecked it on all of them, and didn't see a change. I then tried checking material participation (though I do not qualify for this, I just wanted to see if it changed anything) and still did not see a change.

The real estate activities are not aggregated - they are in separate columns of Schedule E. 

For the K-1, I checked "Limited Partner or Other LLC Member" -> Domestic Partner -> nothing for the percentage of share, liability share, or Capital Account information because I'm not sure what that would be. I said I do NOT materially participate.  I checked "None of these apply" for the "Describe the Partnership" section, Business - Box 1, Not an oil or gas property, and entered the negative number for Box 1 - Ordinary income or loss. I checked "All is at risk" and "No" code Z in Box 20, and no Schedule Q. 

I tried reporting the sale as a Sale of Business Property on 4797, and I also tried reporting it through the "wizard" the runs through the Schedule E in the checkbox asking if the property was sold. 

The resulting 8582 form is no longer listing the sold property on the form, so I assume that the suspended passive losses for that property are being taken into account to offset the portion that they would offset, but, the K-1 and the other investment property are still listed. The bottom of the form is saying that the allocation of unallowed losses is .007 for the investment property and .92 for the K-1 loss, such that the vast majority of the losses is listed as "Unallowed" 

I am very confused by this, because I have seen countless references stating that in the year of selling one rental property, the suspended passive losses of the other rental properties should be released and offset against the capital gains. And if that's the case, it seems like the K-1 losses should do the same. But neither of them are. If I delete the K-1 sample entirely from the tax return, the same issue remains for the suspended passive losses from the rental property - they're not getting released. 

Thank you for your help with this. I'm stumped. 

[nomad6]

To answer this part:

finally, for the 8582 tell us the amounts showing up and the related line number. round to thousands. indicate loss with a minus sign.

Note that the actual values I entered into the tax return are a little different than the examples I used initially in my post because I was trying to simplify, but here are the figures on the 8582:

1a: 20,000

1c: -19,000

1d: 500

2a: 8,000

2b: -170,000

2c: -22,000

2d: -184,000

3: -183,000

Part III

10: 28,000

11: 28,000

Part IV 

Property A  - 20,000 net income, 0 net loss, 19,000 unallowed loss, 500 gain

Part V 

Property B - 8,000 net income, 0 net loss, 22,000 unallowed loss, 0 gain, 13,000 loss (e) 

K1 - 0 net income, 170,000 net loss, nothing entered for unallowed loss or gain, and 170,000 for loss (e) 

Part VI

Ratio - 1.0

Part VII 

Property B - 13,000 loss, .07... ratio, and 13,000 unallowed loss

K1 - 171,000 loss, .92... ratio, and 170,527 unallowed loss

Total  - 184,181 loss, 1.0 ratio, 183,672 unallowed loss 

Part VIII, allowed losses

Property B - loss 22,000, unallowed loss 13,000, allowed loss 8,000

K1 - loss 171,000, unallowed loss 170,527, and allowed loss 473

Total: loss 193,000, unallowed loss 183,000, allowed loss 9,000

Property C is the sold property and it does not appear on the 8582. 

Thank you!! I hope this is organized enough. 

[Mike9241]

1) you did not check the active participation box for the rental properties

please see my prior post as to what constitutes active participation or review form 8283 instructions

2) either my app is not working correctly or you checked some box to indicate that C was not a passive activity for the year or you entered some other info that resulted in Turbotax determining it is not a passive for the year of sale. this is why it's not on the 8582 it's not being treated as passive so can not be used to offset passive losses. Whether this is correct or not, I can't determine. review your input. 

Please consult a pro to review what you have done. 

[AmeliesUncle]

---

@nomad6 wrote:

- Rental Property B (sold) - current losses and suspended losses

---

It was sold at a gain, right?   As much or more gain as all of the other Passive Losses combined?

Go back into the introductory part of Rental B, where you enter the address of the rental, etc.  Look for the box that says you sold it in a fully taxable transaction and check that.

[nomad6]

Thank you for your reply.

So, there are three rental properties total. One rental property was sold at a gain. The current and suspended loss for that rental property appear to have flowed through as expected because that property no longer appears anywhere on the 8582 at all, even though it does appear on the 8582 when I remove the "sale" just like with prior years.

But I have read in several places that the suspended passive losses should be released for the other two properties, since they were not "bundled" and have always been listed separately in the Schedule E. Hall CPA (a Bigger Pockets person) and several others claim that all suspended passive losses for all rental properties should be released in the year of selling any single rental property. 

I'm assuming that I should not and can not check the "sold" checkbox for the properties that did not sell, right?

Also, I am trying to determine whether it would be wise to invest in an LLC that would provide operating losses in Box 1 of the K-1 for the year. I don't believe there would be a tax advantage for me to do this unless it would offset the ordinary income that is due to the sale of this rental property. 

So I have two questions - 

- Is it correct that the suspended passive losses for all the properties should be released, or are all these videos and blogs incorrect? 

- And would investing in the K-1, which would generate additional passive losses to the best of my understanding, also offset the gain?  I'd like to invest in the LLC and receive the K-1, but only if it is correct that it would offset this gain. 

[AmeliesUncle]

It sounds like you did, but just to confirm, did you check the sold box where I told you?

And as I asked before, was the gain at least as much as the total Passive Losses (current and carryover)?

- Is it correct that the suspended passive losses for all the properties should be released, or are all these videos and blogs incorrect? 

- And would investing in the K-1, which would generate additional passive losses to the best of my understanding, also offset the gain?  I'd like to invest in the LLC and receive the K-1, but only if it is correct that it would offset this gain. 

---

Sort of.   They are not directly released due to the sale of a different property.  However, Passive Losses can be used to the extent that you have Passive Income, so they can potentially be used if you have Passive Income.

Because you sold the one passive rental at a gain, you now have Passive Income.  Because you have Passive Income, some (or all) of the Passive Losses can be used (that is why I asked about how much gain you have versus how much losses there are).  But if your losses are more than the gain, the remaining losses will continue to be suspended until you have Passive Income or that property is sold.

[nomad6]

I checked the “sold” box on the schedule E worksheet for the property that sold. I did not check it for the properties that did not sell. Should I?

The gain is higher than all the losses combined, including the K-1 losses. 

if checking the sold box is needed to release the losses on the properties that are still held, how would I release the k-1 losses as well?

also from research I am confused about whether the gain from selling real estate is considered passive or if it moves to ordinary income.

many thanks for your help!

[tagteam]

---

@nomad6 wrote:

.......I am confused about whether the gain from selling real estate is considered passive or if it moves to ordinary income.

---

With respect to rental real estate, to the extent any gain is due to depreciation recapture (unrecaptured Section 1250 gain), that gain is ordinary income and subject to federal income tax at a rate of 0% up to a cap of 25%.

The balance of the gain is then long-term capital gain (technically Section 1231 gain), assuming the property is held longer than one year) and subject to federal income tax at long-term capital gains tax rates (maximum of 20% plus NIIT if applicable).

[nomad6]

Thank you.
can you address my question about how to release the suspended passive losses on the properties that did not sell? Do I tick the “sold” checkbox on all of them even though only one sold?

And how do the K-1 passive losses get released?

[nomad6]

Thank you.
can you address my question about how to release the suspended passive losses on the properties that did not sell? Do I tick the “sold” checkbox on all of them even though only one sold?

And how do the K-1 passive losses get released?

[tagteam]

I think we've gone off track here. 

Suspended passive losses that are released as a result of the sale of a passive activity can be deducted as nonpassive losses. 

Let's start from that point. 

@AmeliesUncle