Comprehensive Example(p11)

The following example shows how to report your passive activities. In addition to Form 1040, U.S. Individual Income Tax Return, Charles and Lily Woods use Form 8582 (to figure allowed passive activity deductions), Schedule E (to report rental activities and partnership activities), Form 4797 (to figure the gain and allowable loss from assets sold that were used in the activities), and Schedule D (to report the sale of partnership interests).

Charles and Lily are married, file a joint return, and have combined wages of $132,000 in 2010. They own interests in the activities listed below. They are at risk for their investment in the activities. They did not materially participate in any of the business activities. They actively participated in the rental real estate activities in 2010 and all prior years. Charles and Lily are not real estate professionals.

1. Activity A is a rental real estate activity. The income and expenses are reported on Schedule E. Charles and Lily's records show a loss from operations of $15,000 in 2010. Their records also show a gain of $2,776 from the sale in January 2010 of section 1231 assets used in the activity. The section 1231 gain is reported in Part I of Form 4797 and is identified as being from a passive activity (FPA). For 2009, they completed the worksheets for Form 8582 and calculated that $6,667 of Activity A's Schedule E loss for 2009 was disallowed by the passive activity rules. That loss is carried over to 2010 as a prior year unallowed loss and will be used to figure the allowed loss for 2010.
2. Activity B is a rental real estate activity. Its income and expenses are reported on Schedule E. Charles and Lily's records show a loss from operations of $11,600 in 2010. For 2009, they completed the worksheets for Form 8582 and calculated that $8,225 of Activity B's Schedule E loss for 2009 was disallowed by the passive activity rules. That loss is carried over to 2010 as a prior year unallowed loss and will be used to figure the allowed loss for 2010.
3. Partnership #1 is a trade or business activity and is not a publicly traded partnership (PTP). Partnership #1 reports a $4,000 distributive share of its 2010 profits to Charles and Lily in box 1 of Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits, etc. They report that profit on Schedule E. For 2009, they completed the worksheets for Form 8582 and calculated that $2,600 of their distributive share of the loss from Partnership #1 in 2009 was disallowed by the passive activity rules. That loss is carried over to 2010 as a prior year unallowed loss and will be used to figure the allowed loss for 2010.
4. Partnership #2 is a trade or business activity and also a PTP. In December 2010, Charles and Lily sold their entire interest in Partnership #2. To indicate they made an entire disposition of a passive activity, they enter EDPA on the appropriate lines. They do not report that sale on Form 8582 because Partnership #2 is a PTP. They recognize a long-term capital gain of $15,300 ($25,300 selling price minus $10,000 adjusted basis) that they report on Schedule D. The partnership reports a $1,200 distributive share of its 2010 losses to them in box 1 of Schedule K-1 (Form 1065). They report that loss on Schedule E. For 2009, they followed the instructions for Form 8582 and calculated that $2,445 of their distributive share of Partnership #2's 2009 loss was disallowed by the passive activity rules. That loss is carried over from 2009 and reported on Schedule E as a loss for 2010. (For a discussion of PTPs, see the instructions for Form 8582.)
5. Partnership #3 is a single trade or business activity and is not a PTP. Charles and Lily's distributive share of partnership losses for 2010 reported in box 1 of Schedule K-1 (Form 1065) is $6,000. Charles and Lily sold their entire interest in Partnership #3 in November 2010. To indicate they made an entire disposition of a passive activity, they enter EDPA on the appropriate lines. They recognize a $4,000 ($15,000 selling price minus $11,000 adjusted basis) long-term capital gain, which they report on Schedule D.For 2009, they completed the worksheets for Form 8582 and calculated that $3,000 of their distributive share of the partnership's loss for 2009 was disallowed by the passive activity rules. That loss is carried over to 2010 as a prior year unallowed Schedule E loss.
   
6. Partnership #4 is a trade or business activity that is a limited partnership. Charles and Lily are limited partners who did not meet any of the material participation tests. Their distributive share of 2010 partnership loss, reported in box 1 of Schedule K-1 (Form 1065), is $2,400. For 2009, they completed the worksheets for Form 8582 and calculated that $1,500 of their distributive share of loss for 2009 was disallowed by the passive activity rules. That loss is carried over to 2010 as a prior year unallowed loss and will be used to figure the allowed loss for 2010.

For 2010, Charles and Lily complete the forms they usually use to report income or expenses from their activities. They enter their combined wages, $132,000, on Form 1040. They complete Schedule D, line 8, showing long-term capital gains of $15,300 from the disposition of Partnership #2 and $4,000 from the disposition of Partnership #3. Partnership #2 is a PTP so it is not entered on Form 8582. The disposition of Partnership #3 is a disposition of an entire interest in an activity with an overall loss of $5,000 ($4,000 − $3,000 − $6,000) so that partnership also is not entered on Form 8582. They combine the PTP $1,200 current year loss with its $2,445 prior year loss and report the combined amount in column (f) on Schedule E, Part II, line 28. They also combine the Partnership #3 $6,000 current year loss with its $3,000 prior year loss, and enter the combined amount in column (h) on Schedule E, Part II, line 28, since they have an overall loss from that activity. Normally, current year and prior year losses should be entered on separate lines of Schedule E. For purposes of this example only, the amounts have been combined on one line. They enter the $4,000 profit from Partnership #1 in column (g). Before completing the rest of Schedule E, Part II, they must complete Form 8582 to figure out how much of their losses from Partnerships #1 and #4 they can deduct.

They complete Schedule E, Part I, through line 22. Their rental activities are passive so they must complete Form 8582 to figure the deductible losses to enter on line 23.

They enter the gain from the sale of the section 1231 assets of Activity A on Form 4797.

Charles and Lily now complete Form 8582 including the worksheets that apply to their passive activities. Because they are at risk for their investment in the activities, they do not need to complete Form 6198 before Form 8582. (The second part of this publication explains the at-risk rules.)

Worksheet 1 is for rental real estate activities with active participation. Charles and Lily enter the gains and losses from Activity A and Activity B on Worksheet 1. They enter all amounts from the activities even though they already reported the gain of $2,776 from Activity A on Form 4797 because all income or loss from these activities must be taken into account to figure the loss allowed.

1. They write "Activity A" on the first line under "Name of activity." Then they enter:
   1. $2,776 gain in column (a) from Form 4797, line 2, column (g),
   2. ($15,000) loss in column (b) from Schedule E, line 22, column A, and
   3. ($6,667) prior year unallowed loss in column (c) from their 2009 worksheets.
   They combine the three amounts. The result, ($18,891), is an overall loss so they enter it in column (e).
   
2. Charles and Lily write "Activity B" on the second line under "Name of activity." Then they enter:
   1. ($11,600) loss in column (b) from Schedule E, line 22, column B, and
   2. ($8,225) prior year unallowed loss in column (c) from their 2009 worksheets.
   Then they combine these two figures and enter the total loss, ($19,825), in column (e).
   
3. They separately add the amounts in columns (a), (b), and (c).
   1. They enter $2,776 in column (a) on the Total line and also on Form 8582, Part I, line 1a.
   2. They enter ($26,600) in column (b) on the Total line and also on Form 8582, Part I, line 1b.
   3. They enter ($14,892) in column (c) on the Total line and also on Form 8582, Part I, line 1c.
4. They combine lines 1a, 1b, and 1c, Form 8582, and put the net loss, ($38,716), on line 1d.

Partnership #1 and Partnership #4 are nonrental passive activities so Charles and Lily enter the appropriate information about those activities on Worksheet 3 in the same way they reported their rental activities on Worksheet 1. Then they enter the totals on Form 8582, Part I, lines 3a through 3d.

Activities that have an overall gain in column (d) are not used any further in the calculations for Form 8582. At this point, all income and losses from those activities should be entered on the forms or schedules that would normally be used. Charles and Lily have one activity with an overall gain ($4,000 − $2,600 = $1,400). This is Partnership #1, which is shown in Worksheet 3. They already reported the $4,000 income from this activity on Schedule E, Part II. They now enter the entire $2,600 loss on Schedule E, Part II, as well.

Next, Charles and Lily complete Form 8582, Part II, to determine the amount they can deduct for their net losses from real estate activities with active participation (Activities A and B). They enter all amounts as though they were positive (without brackets around losses). They then complete Form 8582, Part IV.

• They enter $38,716 on line 5 since this is the smaller of the loss on line 1d or the loss on line 4.
• They enter $150,000 on line 6 since they are married and filing a joint return.
• They enter $138,655, their modified adjusted gross income, on line 7. (See page 4 for discussion of modified adjusted gross income.) The $138,655 is made up of their wages, $132,000, plus their overall gain of $11,655 from Partnership #2, a PTP, less their $5,000 overall loss from Partnership #3. On Schedule D, they reported long-term gains of $15,300 from the PTP disposition and $4,000 from the Partnership #3 disposition. On Schedule E, they combined the PTP 2010 loss of $1,200 with its 2009 loss of $2,445, and combined the Partnership #3 2010 loss of $6,000 with its 2009 loss of $3,000. Netting these amounts gives them the PTP overall gain of $11,655 ($15,300 − $1,200 − $2,445) and the Partnership #3 overall loss of $5,000 ($4,000 − $6,000 − $3,000) that were used in figuring modified adjusted gross income.
• They subtract line 7 from line 6 and enter the result, $11,345, on line 8.
• They multiply line 8 by 50% and enter the result, $5,673, on line 9.
• They enter the smaller of line 5 or line 9, $5,673, on line 10.
• They add the income on lines 1a and 3a and enter the result, $6,776, on line 15.
• They add lines 10 and 15 and enter the result, $12,449, on line 16.

Charles and Lily must complete Worksheet 4 because they entered an amount on Form 8582, line 10, and have two activities, each with an overall loss in Worksheet 1, column (e). Worksheet 4 allocates the amount on line 10 (their special allowance for active participation rental real estate activities) between Activity A and Activity B.

• In the two left columns, they write the name of each activity, A and B, and the schedule and line number on which each activity is reported.
• They fill in column (a) with the losses from Worksheet 1, column (e). They add up the amounts, and enter the result, $38,716, in the Total line without brackets.
• They figure the ratios for column (b) by dividing each amount in column (a) by the amount on the column (a) Total line. They enter each result in column (b). The total of the ratios must equal 1.00.
• They multiply the amount from line 10, Form 8582, $5,673, by each of the ratios in Worksheet 4, column (b) and enter the results on the appropriate line in column (c). The total must equal $5,673.
• They subtract column (c) from column (a) and enter each result in column (d).

Worksheet 5 must be completed if any activity has an overall loss in Worksheet 3, column (e), or a loss in Worksheet 4, column (d) (or Worksheet 1, column (e), if Worksheet 4 was not needed). This worksheet allocates the unallowed loss among the activities with an overall loss. Charles and Lily complete Worksheet 5 with the activities from Worksheet 4 and the one activity showing a loss in Worksheet 3, column (e). They write the name of each activity and the schedule or form and the line number on which each loss will be reported in the two left columns of Worksheet 5.

1. In column (a), they enter the losses from Worksheet 3, column (e) and Worksheet 4, column (d). These losses are entered as positive numbers, not in brackets. They add the numbers and enter the total, $36,943, on the Total line.
2. They divide each of the losses in column (a) by the amount on the column (a) Total line, and enter each result in column (b). The ratios must total 1.00.
3. Now they use the computation worksheet for column (c) (see the worksheet in the instructions for Form 8582) to figure the unallowed loss to allocate in column (c).
   1. On line A of the computation worksheet, they enter the amount from line 4 of Form 8582, $41,216, as a positive number.
   2. On line B, they enter the amount from line 10 of Form 8582, $5,673.
   3. They subtract line B from line A and enter the result, $35,543, on line C. This is the total unallowed loss.

They multiply line C, $35,543, by each of the ratios in column (b) and enter the results in column (c). These amounts are the unallowed losses from each activity and must add up to $35,543.

Charles and Lily now decide whether they must use Worksheet 6, Worksheet 7, or both to figure their allowed losses. If the loss from any activity entered on Worksheet 5 is reported on only one form or schedule, then Worksheet 6 is used for that activity. If an activity has a loss that is reported on two or more schedules or forms (for example, a loss that must be reported partly on Schedule C and partly on Form 4797), Worksheet 7 is used for that activity. All of the activities Charles and Lily entered on Worksheet 5 will be reported on Schedule E. Therefore, they use Worksheet 6 to figure the allowed loss for each activity.

They complete Worksheet 6 with the activities from Worksheet 5.

• They write the name of each activity and the schedule and line number to be used in the two left columns of Worksheet 6.
• In column (a), they enter the total loss for each activity. This includes the current year loss plus the prior year unallowed loss. They find these amounts by adding columns (b) and (c) on Worksheets 1 and 3.
• In column (b), they enter the unallowed loss for each activity already figured in Worksheet 5, column (c). They must save this information to use next year in figuring their passive losses.
• In column (c), they figure their allowed losses for 2010 by subtracting their unallowed losses, column (b), from their total losses, column (a). These allowed losses are entered on the appropriate schedules.

Charles and Lily enter their allowed losses from Activities A and B on Schedule E, Part I, line 23, because these are rental properties. They report their allowed loss from Partnership #4 on Schedule E, Part II, line 28D.

Charles and Lily summarize the entries on Schedule E, Schedule D, and Form 4797, and enter the amounts on the appropriate lines of their Form 1040. They enter:

• The total Schedule D gain, $22,076, on line 13, and
• The Schedule E loss, ($21,094), on line 17.

Charles and Lily are now able to complete their tax return, having correctly limited their losses from their passive activities. taxmap/pubs/p925-001.htm#en_us_publink1000104664 taxmap/pubs/p925-001.htm#en_us_publink1000104665 taxmap/pubs/p925-001.htm#en_us_publink1000104666 taxmap/pubs/p925-001.htm#en_us_publink1000104667 taxmap/pubs/p925-001.htm#en_us_publink1000104668 taxmap/pubs/p925-001.htm#en_us_publink1000104669 taxmap/pubs/p925-001.htm#en_us_publink1000104670 taxmap/pubs/p925-001.htm#en_us_publink1000104671