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              ³ PASSIVE ACTIVITY LOSS LIMITATIONS ³
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As anyone who reads the newspapers knows by now, "passive
activity" losses (i.e., tax shelters) have become an endan-
gered species since the passage of the Tax Reform Act of
1986.  In general terms, a so-called "passive activity" is
one that involves the conduct of a trade or a business, or
an investment activity, in which the taxpayer does not mat-
erially participate.  But rental activities of any type are
considered to be passive regardless of the taxpayer's mater-
ial participation in the business (but certain short-term
rental activities, such as hotel rooms, tuxedos, etc. where
the average customer uses the property for seven days or
less are not considered to be "rental" activities).

@IF159xx]Because your company is engaged in rental activities, it is
@IF159xx]possible that the passive loss restrictions described below
@IF159xx]could apply to @NAME.
@IF159xx]
@IF112xx]However, as long as your corporation is (as it appears) a
@IF112xx]C corporation, but is not considered a "closely-held C corp-
@IF112xx]oration," it may well be exempt from these loss limitations,
@IF112xx]which could be very advantageous, from a tax-planning stand-
@IF112xx]point, for @NAME.
@IF112xx]
@IF112xx]However, see the discussion in this program of "personal ser-
@IF112xx]vice corporations," which ARE subject to passive loss rules.
@IF160xx]Because your firm's business is @BUSTYPE,
@IF160xx]the definition of "personal service corporation" probably
@IF160xx]does not apply to @NAME, fortunately.
@IF160xx]
@IF161  ]Because your firm's business is @BUSTYPE,
@IF161  ]the "personal service corporation" definition is likely to
@IF161  ]apply to @NAME, unfortunately.
@IF161  ]
Under the tax law as it now stands, all of a taxpayer's in-
come and losses go into 3 separate categories:

    . Active source income (such as salary, wages or
      income or loss from an "actively conducted"
      business);

    . Passive activity income or loss (as from a tax
      shelter, or from a rental property); and

    . Portfolio income and related expenses (interest,
      dividends, capital gains).

In general, net losses from passive activities for a tax-
able year cannot be offset against other income, but must
be carried over to future years to be offset against pas-
sive income (if any).  Similarly, net portfolio losses re-
sulting from investment interest expense can't be offset
against either of the other 2 categories.  Only losses from
active sources can be used to currently offset income from
the other 2 categories, generally.

Thus, if you are a passive investor in a partnership or an
S corporation business that has net losses that are con-
sidered passive activity losses, you must carry those
losses forward to future tax years for an indefinite peri-
od, and cannot use the losses until you generate net pas-
sive income against which they can be offset, or else you
sell or otherwise dispose of the investment in a way that
permits you to recognize the deferred losses.

For small businesses, perhaps the most important exception
to these passive loss restrictions is the exception for up
to $25,000 a year of losses from rental real estate, where
the taxpayer is considered to "actively participate" in the
rental activity.  This allowable deduction phases out at
the rate of $1 for every $2 that the taxpayer's adjusted
gross income exceeds $100,000.  Thus, no such deduction is
allowed for rental losses if adjusted gross income is
$150,000 or more.  (Note that adjusted gross income for
this purpose is recomputed without taking into account any
passive losses, IRA deductions, or taxable Social Security
benefits.)

Only a natural person (not a corporation, trust, etc.) can
qualify for the special $25,000 rental loss exception.
Also, to qualify for such a current deduction of rental
losses, the taxpayer must own at least a 10% interest (by
value) in the property, such as a 10% interest in a real
estate partnership.  Thus, you can't obtain this loss by
buying 0.000001% of a large public real estate partnership.
In addition, you must "actively participate" in the activ-
ity.  This means only that you must make major management
decisions about the property, such as hiring a management
company to manage it, or by approving new tenants, setting
rental terms, approving major expenditures, or the like.

The passive loss restrictions apply not only to individual
taxpayers, but also to "personal service corporations," in
full.  They also apply, but only to a limited extent, to
certain other closely-held C corporations, which are al-
lowed to offset passive losses against "net active income,"
but not against portfolio income. C corporations that aren't
"personal service corporations" or "closely-held C corpora-
tions" aren't subject to passive loss restrictions at all.

Finally, neither partnerships nor S corporations are sub-
ject to the passive loss rules, but any passive losses
they pass through to their partners or shareholders will be
subject to the passive loss rules at the partner or share-
holder level.