8612. What are the tax results when a taxpayer disposes of interests in a passive activity?cjumprcline202014-07-07T22:12:00Z2014-07-07T22:12:00Z24692675National Underwriter2263138148612. What are the tax results when a taxpayer disposes of interests in a passive activity?If a taxpayer disposes of his interests in a passive activity in a fully taxable transaction, losses from the activity will receive ordinary loss treatment (i.e., they may generally be used to offset other income of the taxpayer) to the extent that they exceed net income or gain from all passive activities (determined without regard to the losses just discussed) for the year. This treatment applies both to current year losses as well as losses carried over from previous years, with respect to the activity disposed of. The IRS has been given the authority to issue regulations that will take income or gain from previous years into account to prevent the misuse of this rule..IRC Sec. 469(g)(1). For the purpose of determining gain or loss from a disposition of property, the taxpayer may elect to increase the basis of the property immediately before disposition by an amount equal to the part of any unused credit that reduced the basis of the property for the year the credit arose..IRC Sec. 469(j)(9). If the passive interest disposed of is sold under the installment method, previously disallowed passive losses are allowed as a deduction in the same proportion as gain recognized for the year bears to gross profit from the sale..IRC Sec. 469(g)(3).If the disposition of the passive interest is to a related person in an otherwise fully taxable transaction, suspended losses remain with the taxpayer and may continue to offset other passive income of the taxpayer. The taxpayer is considered to have disposed of an interest in a transaction described in the preceding sentence when the related party later disposes of the passive interest in a taxable transaction to a party unrelated to the taxpayer..IRC Sec. 469(g)(1)(B).If the disposition is by death, the carried over losses may be deducted only to the extent the losses exceed the step-up in basis of the interest in the passive activity..IRC Sec. 469(g)(2). If the disposition is by gift, the losses are not deductible. Instead, the donor’s basis just before the transfer is increased by the amount of the disallowed losses allocable to the interest..IRC Sec. 469(j)(6). However, where a donor makes a gift of less than his or her entire interest in property, a portion of the carried over losses is allocated to the gift and increases the donor’s basis. A portion of the losses will continue to be treated as passive losses attributable to the interest that the donor has retained..Sen. Rep. 99-313, 1986-3 CB (vol. 3) 713, 726.If a trust or estate distributes an interest in a passive activity, the basis of such interest immediately before the distribution is increased by the amount of passive losses allocable to the interest, and such losses are never deductible..IRC Sec. 469(j)(12). A taxpayer is not treated as having disposed of the entire interest in an activity of a publicly-traded partnership until the taxpayer disposes of the entire interest in the partnership..IRC Sec. 469(k)(3).Planning Point: IRS Publication 925 (Passive Activity and At-Risk Rules) contains a number of examples of, and various scenarios relating to, passive activities and losses, and includes worksheets and filing instructions necessary for the completed reporting of passive activities.