Passive Activity Loss ATG - Exhibit 9.1: Low Income Housing And Passive Loss Limitations
Publication Date - December, 2004
NOTE: This guide is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date.
Exhibit 9.1: Low Income Housing And Passive Loss Limitations
LAW: Low income housing partnerships are rental activities and are therefore subject to the limitations of IRC § 469, the passive loss rules. The LIH LOSSES and low income housing CREDITS are each treated differently. See IRC § 469(i)(6)(B). For current years, LOSSES are generally subject to the passive loss limitations - just like any other rental real estate activity. Limited partners do not qualify for the $25,000 offset; thus losses are deductible only up to passive income reported on the return. The IRC § 469(i)(6)(B) provides an exception for low income housing CREDITS. There is no participation requirement. Thus, even a limited partner may use the low income housing CREDIT. Furthermore, for current tax years, there is no phaseout of the credit based on MAGI. Therefore, a taxpayer with any amount of income may use the credit. However, the credit is limited to the tax equivalent of $25,000. Furthermore, LIHC are only allowed IF any $25,000 offset remains after rental losses and the rehabilitation credit. Beginning in 1994, there is an exception for a qualifying real estate professional. Under IRC § 469(c)(7), if he materially participates in the LIH project, current losses and credits are fully deductible.
NOTE: The LIH credit is reflected on Form 8586, Low-Income Housing Credit, which is carried to Form 8582-CR, which is carried to Form 3800, General Business Credit, which is ultimately carried to Form 1040. The LIH losses from limited partners should be entered on Form 8582 line 3b, and, if allowable due to passive income, would be carried to the back of Schedule E, the passive loss column.
For taxpayers claiming to be real estate professionals, complete the following two steps.
If the taxpayer is not a real estate professional, SKIP first two steps.
_____ Verify that the taxpayer qualifies as a real estate professional (spends more than half his personal services in real property businesses and more than 750 hours a year – IRC § 469(c)(7)(B) ). A real estate professional is a taxpayer who spends the majority of time on REAL PROPERTY businesses. See IRC § 469(c)(7) & Reg. § 1.469-9.
_____ If the taxpayer is a real estate professional, verify that he materially participated (Reg. § 1.469-9(e)(1) & Reg. § 1.469-5T(a)) in the activity generating the low income housing losses and credits. Since many investors are limited partners (see Schedule K-1), they will not meet the material participation standard - unless a timely written election was filed with the return to group ALL rentals as one activity. If the taxpayer does not materially participate, losses are entered on Form 8582 line 3b and credits should be on Form 8582-CR.
If taxpayer is a qualifying real estate professional AND materially participates in the LIH partnership, STOP! LIH losses and credits are fully deductible. The low income housing credit will not be limited by the passive loss limitations. However, as a practical matter, many investors are limited partners and do not materially participate.
LIH CREDIT ISSUES:
_____ Verify LIH credits on Forms 8586 and 3800 are on Form 8582CR. The LIH credits are most often on FORM 8582-CR line 3.
_____ Review Form 8582-CR and verify that the low income housing credit has been limited to the tax equivalent of $25,000.
_____ Verify that income on Form 8582-CR line 6 is not the tax equivalent of the same amount of income on Form 8582, i.e. a duplication! The same amount of income cannot be used both on Form 8582 for losses and Form 8582-CR for credits. Legitimate passive income from any source will trigger deductibility of low income housing losses and credits. However, passive losses first absorb passive income, followed by certain passive credits, the rehab credit and, lastly, the LIHC.
_____ Verify LIHC have not been deducted on disposition. Passive credits may be claimed only in future years when there is passive income (after absorbing passive losses) OR the taxpayer may elect to increase his basis in the property by any unused credits.
_____ Verify that the taxpayer has computed the tax equivalent of passive income on Form 8582-CR line 6. In other words, verify that the taxpayer has not entered the exact dollar amount of passive income from his documentation, but instead has computed the tax equivalent at his tax bracket. Form 8582-CR instructions provide good information.
_____ Verify that the taxpayer has not improperly deducted credits on disposition of the LIH activity. The taxpayer may elect to increase the basis on the LIH property by completing Form 8582-CR Part VI OR he must continue to carry forward the credit until he has passive income or the $25,000 offset.
LIH LOSS ISSUES:
_____ Verify that losses have been properly reflected on Form 8582 line 3b. Because many investors are limited partners and limited partners do not qualify for the active participation standard under IRC 469(i), losses should be entered on FORM 8582 line 3b (not line 1b which would erroneously give taxpayer benefit of the $25,000 offset). Thus, LIH losses will not be deductible - unless the taxpayer has passive income on FORM 8582 line 1a or 3a OR an entire disposition.
_____ Verify that losses have not been erroneously deducted in the non-passive column on the back of Schedule E.
Exception: A qualifying real estate professional may be able to deduct LIH losses IF he materially participated in the LIH activity (Reg. § 1.469-9(e)(1)) . Many investors are limited partners, and thus will not meet the material participation standard. The IRC § 469(c)(7) and § 469(h).