2.3.2 Passive Activity Loss Treatment

2.3.2.1 Under I.R.C. Sec. 469, “passive activity losses” are not deductible against other income. A “passive activity” is the conduct of a trade or business where the taxpayer does not “materially participate.”

2.3.2.1.1 For trusts, the issue has been who must materially participate – the trustee or the trust itself.

2.3.2.1.2 In Mattie L. Carter, 91 A.F.T.F. 2d 2003-1946; 256 F.Supp.2d 536 (2003), the court held that the trust through its employees, not the trustee, must materially participate. But see, TAM 200733023 holding that the trustee must satisfy the material participation test. Lipton, “Trust’s Material Participation in an Activity Can Only Be Through Its Trustees,” J. Tax, Oct. 2007 (WG&L).

2.3.2.2 Real estate rental losses generally are deemed losses from a “passive activity” and therefore only deductible to the extent that the taxpayer has gains from other passive activities. I.R.C. Sec. 469. An important exception to the passive loss offset rule is afforded to taxpayers with less than $100,000 in gross income (with phase out treatment between $100,000 and $150,000).

2.3.2.2.1 These taxpayers may deduct up to $25,000 in passive losses against other income if the taxpayer actively participates in the activity.

2.3.2.2.2 Estates (but not trusts) qualify for the $25,000 treatment for two years if the decedent materially participated. I.R.C. Sec. 469(i)(4). The full $25,000 amount must be reduced by the amount allowable to the surviving spouse for any given tax years. The two year period is two tax years so a “short year” uses up one of the years.

2.3.2.2.2 “Corrective” legislation — extending parity to trusts – was in the Tax Simplification Bill of 1991 (Sec. 441) which died at the end of 1991 without action. The Taxpayer Relief Act of 1997 added I.R.C. Sec. 646 (now renumbered Sec. 645) to permit certain trusts to elect estate treatment. See below.

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