Wednesday, March 2, 2011

I don't understand the answer to my question. What does it mean?

Q.  After getting our tax return back from our CPA, I noticed our partnership loss wasn't deducted from gross income. When I called him, he was busy, and wouldn't you know, when he returned my call, we were traveling in a dead area and he left a message on my cell saying we didn't get the loss because it was a passive activity. What on earth does that mean? CA, New Mexico

A.  The best way to answer your question is to give you a little background on our income tax laws. Many decades ago, you reported two types of income: (1) capital gains or losses resulting from the sale of capital assets, and (2) ordinary income, which was everything else.

Then, I believe it was in 1986, congress decided more taxpayers needed to pay taxes, and in their wisdom, added two additional classifications of income (3) portfolio income which is basically interest and dividends, and (4) passive activity income, which includes rentals, partnerships which you don't actively participate in, and a few other things as well. You can read all about the Tax Reform Act of 1986  , but I strongly suggest you refrain from printing the 1379 pages!

Since its passage, depending on your filing status and Adjusted Gross Income, you may or may not qualify to take a passive activity loss on your tax return unless you have passive activity gains to offset them. Lacking passive activity gains, your loss will be carried forward on form 8582 to the ensuing year. This can go on for years, until the property in question is disposed. The final disposition of a passive activity frees up accumulated losses to offset any gain which may result in the disposition. If the activity is sold at a loss, both the accumulated passive activity losses together with the loss on the disposition of the property can be taken. Whew - I hope I didn't make things worse!

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