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Discussion:LLC with passive & non-passive activities - Does terminating passive activity free up suspended losses?

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Discussion Forum Index --> Advanced Tax Questions --> LLC with passive & non-passive activities - Does terminating passive activity free up suspended losses?


Discussion Forum Index --> Tax Questions --> LLC with passive & non-passive activities - Does terminating passive activity free up suspended losses?

Marcilio (talk|edits) said:

12 March 2014
Client has LLC with consulting income (non-passive). The company also was in the equipment leasing business (passive). This year, the leasing activity was terminated. There are still some assets on the books, but they were not in service last year. They are worth scrap value only.

Does the termination of the passive activity free up the prior year suspended losses for that activity? The LLC is continuing due to extenuating circumstances, otherwise the entire thing would have been terminated and there wouldn't be a question of how to handle it.

Ckenefick (talk|edits) said:

12 March 2014
The fact that the LLC continues doesn't matter. Nor does it matter that the non-passive activity within the LLC continues, as the rules apply to "activities," not entities.

The issue, however, is that the word "all" and "complete" is used in a few places, including the senate report, as in "all" assets must be disposed of in a fully taxable transaction. However, seems you could argue that the idle assets were removed from the passive activity prior to its disposition, meaning that the passive activity was completely disposed of along with "all" of its, that were dedicated to that passive activity, at the time of disposition. A great argument? I'm not so sure...

Marcilio (talk|edits) said:

13 March 2014
That's a good thought. As it turns out, the one remaining asset is a twin engine airplane that has been grounded by the FAA due to manufacturing defects. The company went bankrupt (duh). They would have to replace both engines at $150k per. That's more than the plane is worth. If we re-class that to the non-passive activity....hmmm.

Ckenefick (talk|edits) said:

13 March 2014
If we re-class that to the non-passive activity....hmmm.

Yeah, hmmmm. Or, we reclass it to no activity, seeing that it's idle.

Marcilio (talk|edits) said:

13 March 2014
That sounds even better.

Death&Taxes (talk|edits) said:

13 March 2014
I wonder if having an LLC is blinding us to the essential nature of this 'disposal.' When you read the reasoning of TRA 86, they tried to include the entities they were familiar with at that time: "the provision applies to individuals, estates, trusts and personal service corporations."

Would the answer be the same if an individual held an airplane for rental and ceased the activity because of the same reason? The first paragraph of the "overview" in the Committee explanation states 'suspended losses from an activity are allowed in full when the taxpayer disposes of his entire interest in the activity.'

By the reasoning of 'no activity' investors in rental properties at the Jersey shore would take their suspended losses when their houses were destroyed after Sandy, especially those who did not carry flood insurance.

Ckenefick (talk|edits) said:

13 March 2014
But what about the "fully taxable transaction" lingo...

Marcilio (talk|edits) said:

13 March 2014
No activity isn't the same as walking away from the activity. Using your Jersey shore example, suppose someone was renting out a house - mortgage free, but didn't have the proper insurance, and he/she decided not to rebuild, but just abandon the property. Could the suspended losses be deducted? I think so. Even though the land would have value and wouldn't be disposed, the rental activity is terminated. I think the nature of the asset has been converted to "other asset", and there can be a 100% disposition of the assets in the activity.

Death&Taxes (talk|edits) said:

13 March 2014
In the Explanation of the Provision, we have another word to interpret: "Suspended losses from an activity are allowed in full when the taxpayer disposes of his entire interest in the activity."

In that sentence is also 'entire interest' and I would think having the airplane in a hanger, or holding on to the land, would not be a disposition of the entire interest.

Markb29 (talk|edits) said:

13 March 2014
agree with D & T . can't measure true economic loss until investment in airplane is liquidated - a basic tenet of the PAL rules.

Ckenefick (talk|edits) said:

13 March 2014
I'm not saying that position is wrong, and, a judge might say it's right. But what about the notion of removing an asset from a passive activity prior to the disposition of the activity...is it possible? Do we need more facts or is the inquiry a non-starter? For example, Marcilio, was this the *only* asset in the rental activity? Or, was a bunch of stuff rented and all of it but this one asset was not sold?

"Suspended losses from an activity are allowed in full when the taxpayer disposes of his entire interest in the activity."

That is and isn't the relevant language. It is clear we need a complete disposition in a taxable transaction. But an activity is made of assets. If, for example, we own the assets outright, the measuring stick is a disposition of the assets. If we own the assets indirectly, say through a partnership, the measuring stick is the disposition of the partnership interest, but could also be the underlying assets.

Sounds like OP owned the assets directly. Other than somewhat sound logic, what is to prevent one from removing a scrap value asset on Date X from the bucket of assets used in the activity, and then disposing of all remaining activity assets on Date Y? If it might work, then all remaining assets in the activity, on the disposition date, have been disposed of in a taxable transaction.

DaveFogel (talk|edits) said:

13 March 2014
Is abandonment or worthlessness treated as a “disposition”? In Bilthouse v. United States, 553 F.3d 513 (7th Cir. 2009), the IRS conceded that a loss from the worthlessness of stock was a disposition under IRC §469(g).

Ckenefick (talk|edits) said:

13 March 2014
Wow, Dave is back. Welcome back, Dave.

I agree. Yet, I think the "problem" Marcilio might have is that the asset wasn't even abandoned. Sounds like the guys believe it to have some value and therefore have not abandoned or relinquished it....Marcilio says "scrap value," but I have no idea what that is with an airplane.

By the way, did you know Iron Maiden has its own airplane?

https://www.youtube.com/watch?v=dvW5dTgNjXM

Nilodop (talk|edits) said:

13 March 2014
By the way, did you know Iron Maiden has its have their own airplane?

Death&Taxes (talk|edits) said:

13 March 2014
Perhaps were this a WWI biplane made of cloth and wood, there would be little worth once retired, but metal? Twin engine....the parts should be worth something, just as the land down here is worth 70-80% of the cost of property.

Ckenefick (talk|edits) said:

13 March 2014
the parts should be worth something,

Totally true. Otherwise, Marcilio's guy wouldn't be hanging on to it...and paying to store it, etc.

So, I think it is definite the plane hasn't been abandoned. No overt act to do so has taken place. (I wonder if prop tax is still being paid on it, insurance, etc.)...but I still wonder about the idea of slotting it over to nowhere or "some other activity" prior to disposition...but I agree, this idea might never work, or it might work in some instances, but maybe not in this one. I'm just trying to think of something for Marcilio...

Marcilio (talk|edits) said:

14 March 2014
In this case the plane can't be flown. The engines tend to crap out in mid-flight, so unless they buy new ones at $150k a pop for a plane that would be worth less than that when fully airworthy...well you get the idea. It's true that the plane hasn't been abandoned, but as far as leasing it, that can't happen. The situation comes to this: If a partnership conducts two separate activities, a fully taxable disposition by the partnership of all the assets used in one activity is a disposition of the partners' entire interest in the activity (Senate Committee Report to P.L. 99-514 (1986)). So, my question remains, can conversion of property to a different activity be considered to be a disposition?

Not every transfer of property is a sale or exchange, but a transfer may be a taxable disposition without being a sale or exchange. However, without the airplane being worthless, I'm having trouble considering this to be a taxable event.

There is something in the new repair regs (proposed at least) that states a qualifying disposition is one that does not involve all the assets, the last asset, or the remaining portion of the last asset, remaining in a general asset account and that is: ... a direct result of a cessation, termination, or disposition of a business, manufacturing, or other income-producing process, operation, facility, plant, or other unit (other than by transfer to a supplies, scrap, or similar account). That "transfer" language doesn't look good.

Ckenefick (talk|edits) said:

14 March 2014
So, my question remains, can conversion of property to a different activity be considered to be a disposition?

As a general proposition, I would say no. I would like to know more about the activity, however.

If I own an office condo, which I rent out, but later decide to move my Schedule C business into it...no way are the previously unallowed passive losses going to be allowed as a result of the conversion.

But if Marcilio and I have 10 office condos we rent out through a partnership, and Ck pisses Marcilio off one day, such that Marcilio wants out, and such that the partnership distributes one unit out to each of us, leaving 8 inside of the partnership...what happens if all 8 are sold in the following year and the partnership is liquidated? Can we take the loss at that time, or does the removal of the 2 units in the preceding year taint things?

Ckenefick (talk|edits) said:

14 March 2014
Jacob R. Ramsburg, Jr., et ux. v. Commissioner, TC Memo 2005-252

See this case. A good portion of it concerns 469(g).

Am wondering, though, if a related party sale would do the trick...(one that doesn't run afoul of the related party rules)

Death&Taxes (talk|edits) said:

14 March 2014
Isn't there something in the way limited real estate partnerships will give enough information to the investors to separate the activities so that on disposal of one activity there can be a write-off of losses? This isn't much help to Marcilio where there is only one passive activity, but the idea holds true.

Terry Oraha (talk|edits) said:

14 March 2014
Absolutely. Real Estate Developers do it all the time with investigation costs, but those are outright abandonments. I think the issue here is that its not over until its over, and from what I'm hearing it's not over!

Terry Oraha (talk|edits) said:

14 March 2014
And what's this about Dave being back! How wonderful. Hi Dave!

DaveFogel (talk|edits) said:

14 March 2014
Hi Terry.

As I said, in Bilthouse v. United States, 553 F.3d 513 (7th Cir. 2009), the IRS conceded that a loss from the worthlessness of stock was a disposition under IRC §469(g).

The parties agree that the Bilthouses’ entire interest in S & E was “dispose[d] of for purposes of section 469(g) whenever their stock in the corporation became “worthless.”

So, if the plane was worthless (would cost more to fix than not), then isn't this a disposition?

Ckenefick (talk|edits) said:

14 March 2014
OP says it has "scrap value," which speaks of value, but OP might be making light of the situation. If everything else is fine with the plane, someone might be willing to buy it, and replace the engines, as opposed to buying a new plane outright. Maybe. And,

I'll admit, the abandonment issue is very touchy and convoluted. IRS seems to think that the asset has to be worthless. In the real world however, people walk away from assets that might have value, but it might take a lot of time and effort to realize that value, so they walk away. I think it was Wiles or JAD that had a post on this issue a year or so ago.

Also, OP didn't answer my questions about: Are they still paying property tax on it? Are they still paying insurance on it? And, surely, this plane is being stored somewhere and OP is likely paying a cost here too.

Also wondering if the plane is encumbered.

Even though the abandonment issue might be a thorny one, with something that arguably has value, my take is that the plane hasn't been abandoned. It doesn't seem that an overt act has taken place to relinquish it and it also seems that it has value.

I don't know if Marcilio is gonna get a good answer here. And, he also didn't answer the question about this rental activity and how many assets were involved with it.

Marcilio (talk|edits) said:

17 March 2014
It took quite a bit of time to sort this one out. The client decided that it is wisest to dispose of the asset entirely in 2014. There is a lot of money in the suspended losses ($450k) and the risk of disallowance is too great. We might have had an argument, but since airplane deductions are high profile anyway, he decided to take the prudent path. Thanks for all your comments.

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