| Date: | 04/03/1989 |
|---|---|
| Organization: | Massachusetts Department of Revenue |
| Referenced Sources: | Massachusetts General Laws |
Personal Income Tax
Introduction
The federal Tax Reform Act of 1986 ("TRA '86") added the passive activity loss rules of section 469 to the Internal Revenue Code (the "Code") for taxable years beginning January 1, 1987. The new provision limits the amount of passive activity loss that can be claimed as a deduction for federal income tax purposes. Through Chapter 106 of the Acts of 1988, Massachusetts adopted for income tax purposes the Code as amended on January 1, 1988, and in effect for the taxable year.
In general, a passive activity loss is the amount, if any, by which the passive activity deductions for the taxable year exceed the passive activity gross income for the taxable year. Temp. Reg. § 1.469-2T(b)(1). Generally, passive activity losses may not be deducted from other income for the taxable year. I.R.C. § 469. The passive activity loss is suspended and carried forward to reduce passive activity income generated in future years. A taxpayer who disposes of the taxpayer's entire interest in the activity in a fully taxable transaction to an unrelated party may at the time of disposition claim any unused suspended deductions in full.
Federal income tax limitations and phase-out amounts for passive activity loss deductions and rental real estate apply for Massachusetts income tax purposes to resident, part-year resident, and nonresident taxpayers. All taxpayers must maintain records sufficient to substantiate passive activity income and losses. The purpose of this Technical Information Release (TIR) is to clarify, for taxable years beginning on or after January 1, 1988, four major issues on the Massachusetts treatment of passive activity losses.
1. Calculation of Passive Activity Losses for Massachusetts Purposes
A. Full-year residents
The Massachusetts treatment of passive activity losses for Massachusetts residents is the same as the federal treatment. Allowable losses are the same losses that are allowed on federal Form 8582, line 19, to the extent that the losses were not deducted
on the taxpayers' Massachusetts returns in prior taxable years. Also, the net passive activity income or loss is the same as allowed on federal Form 8582, line 17. To the extent there are applicable adjustments for Massachusetts differences, taxpayers must calculate allowable losses on a pro forma federal Form 8582. Taxpayers must refer to section four of this TIR to determine reporting requirements for passive losses incurred before January 1, 1988. Losses disallowed for federal purposes are likewise disallowed for Massachusetts purposes.
B. Nonresidents
For nonresidents, passive activity income and losses which are not attributable to Massachusetts must be taken out of the amounts of these items reported for federal purposes. For Massachusetts purposes, a nonresident must recalculate allowed passive activity losses based upon income or losses from passive activities which generate income subject to tax in Massachusetts. To do so, the taxpayer must complete a pro forma federal Form 8582, using only those amounts from activities which generate income subject to Massachusetts tax.
When completing the pro forma federal Form 8582, the taxpayer must limit the amount of the $25,000 allowance for rental real estate activities with active participation to the amount which was allowed the taxpayer for federal purposes. For example, if a taxpayer had federal adjusted gross income in excess of $100,000 which reduced or eliminated the offset allowance under I.R.C. § 469(i)(3)(A), the taxpayer is limited to the same amount taken on the federal return for Massachusetts purposes.
The following example illustrates how a nonresident calculates passive activity losses for Massachusetts purposes:
During taxable year 1988, Taxpayer Smith, a full-year nonresident, owned an interest in five passive activities:
Activity A is a limited partnership interest which was acquired before October 23, 1986. Smith's distributive share of the net loss for 1988 $12,000. None of the loss is attributable to Massachusetts.
Activity B is a limited partnership interest which was also acquired before October 23, 1986. Smith's distributive share of the net income for 1988 is $2,000. None of the income is attributable to Massachusetts.
Activity C is a general partnership interest which was acquired before October 23, 1986. The general partnership owns rental real estate located in New York. Smith actively participates in the rental real estate activity. Smith's distributive share of the net loss for 1988 is $10,000, none of which is attributable to Massachusetts.
Activity D is a general partnership interest which was acquired after October 23, 1986. The general partnership owns rental real estate located in Massachusetts. Smith actively participates in the rental real estate activity. Smith's distributive share of the net loss for 1988 is $20,000 for federal and Massachusetts purposes.
Activity E is an active participation rental real estate activity which was acquired before October 23, 1986. It consists of Property A, located in Massachusetts, and Property B, located in Vermont. For federal purposes, Smith's distributive share of the net loss is $5,000. For Massachusetts purposes, Smith's share of the net loss is $10,000.
Under the federal rules, Smith would compute the following allowed and disallowed losses:
Activity Inc./Loss Pre-limit Loss Disallowed Inc./Loss Allowed
A (12,000) (8,727) ( 3,273)*
C (10,000) (2,078) ( 7,922)*
D (20,000) (4,156) (15,844)*
E ( 5,000) (1,039) (3,961)*
Subtotal (47,000) (16,000) (31,000)**
B -2,000 - 2,000
Total (45,000) (16,000) (29,000)
* (From Form 8582 Worksheets)
**(From Form 8582, Line 19, & Worksheet 5)
Only Activities D and E generate income subject to Massachusetts tax. Smith completes pro forma federal Form 8582 with amounts pertaining only to those activities. After the required calculations, the resulting figures are as follows:
Activity Inc./Loss Before Limit Loss Disallowed Allowed Loss
D (20,000) (3,333) (16,667)
E (10,000) (1,667) ( 8,333)
Total: (30,000) (5,000) (25,000)
Smith has $25,000 in allowable passive activity losses for Massachusetts purposes for 1988.
C. Part-year residents
Part-year residents who meet threshold income and exemption requirements of G.L. c. 62C, § 6(a) and who change status during a single taxable year from resident to nonresident, or from nonresident to resident, must file two returns. These taxpayers must file Form 1 for the period of the year during which they were residents and Form 1-NR for the period of the year during which they were nonresidents. G.L. c. 62C, § 6(a); 830 CMR 62.5A.1(7)(d). Part-year residents must figure passive activity losses separately for their periods of residency and nonresidency.
Assuming that Smith in the example above was a Massachusetts resident for 105 days in taxable year 1988, passive activity losses are calculated as follows:
Form 1
1) Determine the net passive activity income (loss) which a full-year resident would report for federal purposes, with applicable Massachusetts adjustment differences. (i.e. $31,000 allowed passive losses + $2,000 passive income = $29,000 total losses).
2) Multiply this amount by number of days as a resident
365
(i.e. $29,000 x 105 = $8,342.46).
365
3) The result is the amount of passive activity loss to which Smith is entitled on
Form 1.
Form 1-NR
1) Determine the amount of passive activity loss deduction as if full-year nonresident (i.e. pro forma federal Form 8582, line 19, recalculation showing only those amounts from activities which generate income subject to Massachusetts tax: i.e. $25,000).
2) Subtract the amount taken on Form 1 from this amount
(i.e. $25,000 - $8,342.46 = $16,657.54).
3) Multiply this result by total Mass. losses
total federal losses
(i.e. $16,657.54 x $30,000 = $10,632.47)
$47,000
4) The result is the amount of passive activity loss to which Smith is entitled on Form 1-NR.
2. $25,000 Offset for Rental Real Estate Activities with Active Participation
As an exception to the general rule, I.R.C. § 469(i) allows qualifying taxpayers who actively participate in certain rental real estate activities to deduct from other income up to $25,000 in losses and credits. Under the federal rules, married persons filing joint returns may deduct up to the full amount if they otherwise meet the requirements of I.R.C. § 469. Under the federal rules, married taxpayers filing separate returns who lived apart during the entire taxable year and who otherwise meet the requirements of I.R.C. § 469 are eligible to deduct up to one half of the allowable income and phase-out amounts. Under the federal rules, married taxpayers filing separate federal returns who lived together at any time during the taxable year are not entitled to any offset. I.R.C. § 469(i)(5).
Massachusetts follows the federal rules for applying the $25,000 offset for rental real estate activities with active participation: married taxpayers filing joint Massachusetts returns may deduct up to the full amount if they otherwise meet the requirements of I.R.C. § 469; married taxpayers filing separate Massachusetts returns who lived apart during the entire taxable year and who otherwise meet the requirements of I.R.C. § 469 are eligible to deduct up to one half of the allowable income and phase-out amounts; and married taxpayers filing separate Massachusetts returns who lived together at any time during the taxable year are not entitled to the $25,000 offset. These rules apply even if the taxpayers were allowed to file joint federal returns but were unable to file joint Massachusetts returns because of different Massachusetts filing requirements.
3. Offsetting Excess Part B Passive Losses Against Part A Income
Generally, Massachusetts income taxpayers may not use excess Part B (5%) deductions to offset Part A (10%) income. DD 86-28; 86-29. However, a taxpayer may use the excess of Part B adjusted gross income deductions over Part B income to offset Part A income where two requirements are met: G.L. c. 62, § 2(c)(1);
1) the Part B deductions must be those taken against Part B gross income to compute Part B adjusted gross income ("AGI deductions"), G.L. c. 62, § 2 (c)(1); and
2) the Part A income must be effectively connected with the active conduct of the taxpayer's trade or business. Part A income which is unrelated to a trade or business of the taxpayer may not be reduced by the excess Part B adjusted gross income deductions. G.L. c. 62, § 2(c)(1).
For Massachusetts purposes, taxpayers may not deduct passive activity losses which are not allowed to be deducted under I.R.C. § 469. In addition, taxpayers may not offset excess Part B passive activity losses against Part A income except in the following instances:
1) The excess of Part B adjusted gross income deductions over Part B gross income resulting from any offset allowance for rental real estate activities in which the taxpayer actively participated, as defined in I.R.C. § 469(i), may be used to offset Part A income, but only to the extent that the Part A income is effectively connected with the active conduct of a trade or business of the taxpayer.
2) Carryover passive losses which, under I.R.C. § 469(g), may be taken upon disposition of a taxpayer's entire interest in the passive activity to an unrelated party in a fully taxable transaction may be used to offset Part B or Part A income in the following order:
(a) Part B income attributable to the disposed passive activity for the taxable year;
(b) Part B income attributable to all other passive activities for the taxable year;
(c) Any other Part B income;
(d) Part A income attributable to the disposed passive activity for the taxable year;
(e) Other Part A income which is effectively connected with the active conduct of a trade or business of the taxpayer.
Please note that passive loss carryover deductions are different from net operating loss deductions. Under G.L. c. 62, 2(d)(1)(C) net operating loss deductions under Code § 172 are not deductions for Massachusetts purposes.
4. No Carryforward of Passive Losses Incurred Before January 1, 1988 and Already Deducted for Massachusetts purposes.
For federal purposes, for taxable years beginning on or after January 1, 1987, losses disallowed because of the passive loss rules of Code section 469 could be carried forward to succeeding taxable years to offset future passive income. Because Massachusetts did not adopt TRA '86 changes until 1988, for the taxable year beginning on or after January 1, 1987, but before January 1, 1988, passive activity losses, like other losses, were deducted from Massachusetts gross income to reach Massachusetts adjusted gross income. Taxpayers reported the taxable income difference due to the different U.S. and Massachusetts loss rules on the appropriate Massachusetts schedules with the explanation, "Taxable income differences due to different Mass. and U.S. loss rules (net passive activity loss)."
In general, taxpayers should report the same amount of passive losses on their 1988 Massachusetts tax returns as they report on their 1988 U.S. tax returns. Differences in 1987 amounts reported for U.S. and Massachusetts tax purposes should be adjusted for when the property is disposed of or when the deduction is used up. However, taxpayers who carry over an amount from 1987 for U.S. tax purposes may not deduct the losses again for Massachusetts purposes if they already used these losses to offset their Part B (5%) income for their 1987 Massachusetts return.
For example, a taxpayer who had $15,000 of passive losses in 1987 which could not be set off against other income on the U.S. return was entitled to carry over those losses to 1988 for U.S. tax purposes. However, the taxpayer was able to use those losses to offset Part B income in full on the 1987 Massachusetts return. The taxpayer who uses this $15,000 carryover loss for U.S. tax purposes in 1988 to offset $15,000 in income from a passive activity must record a U.S./Massachusetts difference of $15,000 in taxable income since the losses were used in 1987 for Massachusetts tax purposes. Any amount of losses which exceeded the taxpayer's 1987 Part B income on the 1987 Massachusetts return is not available for carryover to later years' Massachusetts returns.
Stephen W. Kidder
Commissioner of Revenue
TIR 89-2