In general, are passive loss carryovers preferable to NOL carryovers?

[chucknjr]

It seems in the past that when I've had an NOL, the full amount doesn't carryover to the next year after taking it through the IRS's complicated NOL carryover worksheet calculations which always seem to nip a good chunk of it away.  And also NOLs are removed for AMT purposes so I lose benefit there too.  Meanwhile, passive activity loss carryovers last forever and don't decay each year like NOLs seem to do and don't seem to be affected by AMT.  I know there are a lot of nuances to give an exact answer to this question, but do I have the general idea right?

[tagteam · Accepted solution]

I believe you have the idea fundamentally correct, except you may be glossing over the fact that an NOL, being calculated on that worksheet, is designed to eliminate losses other than losses related to your trade or business.

A passive loss can be suspended and carried over from year to year until there is passive income to be offset or until there is a disposition, but an NOL can be used immediately to offset all other income, as well as being carried back to previous tax years with respect to the unused amount.

[AmeliesUncle]

Maybe I'm reading too much into your question, but I also want to point out that you can't really pick-and-choose.  If you are allowed to use a Passive Loss, you can't decide to not use it to avoid a NOL.  The passive loss must be used if you are allowed it.

[Anonymous]

it depends on your return and how you look at things.  an NOL would reduce taxable income from all other sources in the following year (assuming you made the election to carry it forward)  thus reducing your tax bill.  a passive loss can only be used against passive income unless the activity is disposed of. so a PAL from an activity that still exists could be carried over for an unlimited amount of years and thus producing no tax benefit. so do you prefer to benefit currently or possibly in a decade?  some taxpayers even die without ever being able to use the PAL. 

[tagteam]

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@Anonymous wrote:

....some taxpayers even die without ever being able to use the PAL. 

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Yes, they do. and some die without ever being able to use their capital losses.

In short, I'd rather have an NOL since I know I will almost certainly be able to use it the following tax year (if I decide to make the election).

[chucknjr]

Thanks and good point, I did gloss over that PAL can only be offset by passive income while NOLs can offset non business income.  If someone had a bunch of PAL and wanted to generate passive income to offset, I guess the likely way is to invest in a small business partnership (that generates ordinary business income) you're not actively involved in or to non professionally invest in a real estate partnership?  Investing in hedge funds and debt funds seems to mostly generate capital gains, interest, and dividends so those wouldn't be good choices from what I've seen.  The other option is to completely dispose of the partnership source of the PAL which releases the full amount of PAL into ordinary income from what I understand, but then if the PAL is really large and greater than your other income that year, then you generate a NOL and we're back to the problems of large NOLs.  

Speaking of which, one can elect not to use an NOL in a given year right?  If you elect not to use it, do you just carryover the full amount to the next year or is it reduced by the calculations in the NOL worksheet every year you don't use it?   Also, what was the idea behind that complicated NOL worksheet in the first place.  Why not just allow people to use their full NOLs to offset future income?  

[tagteam]

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@chucknjr wrote:

Speaking of which, one can elect not to use an NOL in a given year right?  If you elect not to use it, do you just carryover the full amount to the next year or is it reduced by the calculations in the NOL worksheet every year you don't use it? 

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If you are really interested in this subject, you can start by reading the IRS publication at the link below and note that the CARES Act revised some provisions of the TCJA.

https://www.irs.gov/publications/p536

Otherwise, you can waive the carryback period and carry an NOL forward but you cannot elect to skip a subsequent tax year; you must apply the NOL to each consecutive tax year until it is fully exhausted.

[chucknjr]

Thank you for the correction on the NOL carryforward rules.  

Generally, would non professionally investing in real estate partnerships be a good way of generating passive income to offset PAL carryovers?

[tagteam]

@chucknjr 

The answer to your question would be entirely dependent upon the type of partnership and, more importantly, the partnership's results (t is always for possible for the partnership to sustain a loss).

If you are referring to REITs, those will not work because the type of income they generate is not considered passive income; REITs pass through ordinary dividends, gain, and return capital.

[chucknjr]

Good point about REITs, I'll keep that in mind.  But I meant non REIT real estate partnerships in the form of an LLC or an LP.  For example, I'm actually invested in one, where I'm a limited partner, that bought 10 single family houses and is currently sitting on them for rental income.  The vast majority of income is box 2 net rental real estate income.  I just tested increasing that box2 amount in TurboTax in the the return where I have lots of PAL carryovers and indeed that box 2 income does offset PALs.  It seems a requirement though is that you don't actively participate in the partnership otherwise that box 2 income becomes ordinary.  Materially participating but not actively somehow still keeps the gain as passive.  Go figure. 

One of the houses was sold last year and that generated a combo of box 9c "unrecaptured section 1250 gain" and box 10 "net section 1231 gain."  I'm still playing around with how these affect AGI and PAL carryovers as it seems more complicated so far.  I'll update this thread with what I find later in case it helps someone.

Btw tagteam, you are very knowledgably about taxes.  Are a professional tax preparer or a just tax enthusiast? : )  I appreciate your help very much!