Publication 925 |
2000 Tax Year |
Comprehensive Example
The following example shows how to report your passive activities.
In addition to Form 1040, Charles and Lily Woods use Form 8582 (to
figure allowed passive activity deductions), Schedule E (to report
rental activities and partnership activities), Form 4797 (to figure
the gain and allowable loss from assets sold that were used in the
activities), and Schedule D (to report the sale of partnership
interests).
General Information
Charles and Lily are married, file a joint return, and have
combined wages of $132,000 in 2000. They own interests in the
activities listed below. They are at risk for their investment in the
activities. They did not materially participate in any of the business
activities. They actively participated in the rental real estate
activities in 2000 and all prior years. Charles and Lily are not real
estate professionals.
- Activity A is a rental real estate activity. The income and
expenses are reported on Schedule E. Charles and Lily's records show a
loss from operations of $15,000 in 2000. Their records also show a
gain of $2,776 in 2000 from the sale of section 1231 assets used in
the activity. That section 1231 gain is reported in Part I of Form
4797. In 1999 they completed the Worksheets in the instructions for
Form 8582 and calculated that $6,667 of Activity A's Schedule E loss
for 1999 was disallowed by the passive activity rules. That loss is
carried over to 2000 as a prior year unallowed loss and will be used
in figuring the allowed loss for 2000.
- Activity B is a rental real estate activity. Its income and
expenses are reported on Schedule E. Charles and Lily's records show a
loss from operations of $11,600 in 2000. In 1999 they completed the
Worksheets in the instructions for Form 8582 and calculated that
$8,225 of Activity B's Schedule E loss for 1999 was disallowed by the
passive activity rules. That loss is carried over to 2000 as a prior
year unallowed loss and will be used in figuring the allowed loss for
2000.
- Partnership #1 is a trade or business activity and is not a
publicly traded partnership (PTP). Partnership #1 reports a $4,000
distributive share of its 2000 profits to Charles and Lily on line 1
of Schedule K-1 (Form 1065). They report that profit on Schedule
E. In 1999 they completed the Worksheets in the instructions for Form
8582 and calculated that $2,600 of their distributive share of the
loss from Partnership #1 in 1999 was disallowed by the passive
activity rules. That loss is carried over to 2000 as a prior year
unallowed loss and will be used in figuring the allowed loss for 2000.
- Partnership #2 is a trade or business activity and also a
PTP. In 2000 Charles and Lily sold their entire interest in
Partnership #2. They do not report that sale on Form 8582 because
Partnership #2 is a PTP. They recognize a long-term capital gain of
$15,300 ($25,300 selling price minus $10,000 adjusted basis), which
they report on Schedule D. The partnership reports a $1,200
distributive share of its 2000 losses to them on line 1 of Schedule
K-1 (Form 1065). They report that loss on Schedule E. In 1999
they followed the instructions for Form 8582 and calculated that
$2,445 of their distributive share of Partnership #2's 1999 loss was
disallowed by the passive activity rules. That loss is carried over
from 1999 and added to the $1,200 Schedule E loss for 2000. (For
discussion of PTPs, see the instructions for Form 8582.)
- Partnership #3 is a single trade or business activity and is
not a PTP. Charles and Lily sold their entire interest in Partnership
#3 in November 2000. They recognize a $4,000 ($15,000 selling price
minus $11,000 adjusted basis) long-term capital gain, which they
report on Schedule D.
In 1999 they completed the Worksheets in the Form 8582 instructions
and calculated that $3,000 of their distributive share of the
partnership's loss for 1999 was disallowed by the passive activity
rules. That loss is carried over to 2000 as a prior year unallowed
Schedule E loss. Charles and Lily's distributive share of partnership
losses for 2000 reported on line 1 of Schedule K-1 (Form 1065)
is $6,000.
- Partnership #4 is a trade or business activity that is a
limited partnership. Charles and Lily are limited partners who did not
meet any of the material participation tests. Their distributive share
of 2000 partnership loss, reported on line 1 of Schedule K-1
(Form 1065), is $2,400. In 1999 they completed the Worksheets in the
Form 8582 instructions and calculated that $1,500 of their
distributive share of loss for 1999 was disallowed by the passive
activity rules. That loss is carried over to 2000 as a prior year
unallowed loss and will be used in figuring the allowed loss for 2000.
Step One--Completing the Tax Forms Before Figuring the
Passive Activity Loss Limits
Charles and Lily complete the forms they usually use to report
income or expenses from their activities. They enter their combined
wages, $132,000, on Form 1040. They complete line 8 of Schedule D
showing long-term capital gains of $15,300 from the disposition of
Partnership #2 and $4,000 from the disposition of Partnership #3.
Because Partnership #2 is a PTP, it is not entered on Form 8582.
Because the disposition of Partnership #3 is a disposition of an
entire interest in an activity with an overall loss of $5,000 ($4,000
- $3,000 - $6,000), that partnership also is not entered
on Form 8582. They combine the PTP $1,200 current year loss with its
$2,445 prior year loss, and also combine the Partnership #3 $6,000
current year loss with its $3,000 prior year loss, and enter the two
combined amounts in column (g) on line 27 of Schedule E, Part II. They
enter the $4,000 profit from Partnership #1 in column (h). Before
completing the rest of Part II of Schedule E, they must complete Form
8582 to figure out how much of their losses from Partnerships #1 and
#4 they can deduct.
They complete Schedule E, Part I, through line 22. Since their
rental activities are passive, they must complete Form 8582 to figure
the deductible losses to enter on line 23.
They enter the gain from the sale of the section 1231 assets of
Activity A on Form 4797.
Step Two--Form 8582
and its Worksheets
Charles and Lily now complete Form 8582 and the worksheets that
apply to their passive activities. Because they are at risk for their
investment in the activities, they do not need to complete Form 6198
before Form 8582. (The second part of this publication explains the
at-risk rules.)
Worksheet 1.
On Worksheet 1, Charles and Lily enter the gains and losses for
Activity A and Activity B (rental real estate activities with active
participation). They enter all amounts from the activities even though
they already reported the gain of $2,776 from Activity A on Form 4797,
since all income or loss from these activities must be taken into
account to figure the loss allowed.
- They write "Activity A" on the first line under
Name of activity. Then they enter:
- $2,776 gain in column (a) from Form 4797, line 2, column
(g),
- ($15,000) loss in column (b) from Schedule E, line 22,
column A, and
- ($6,667) prior year unallowed loss in column (c) from their
worksheets used in 1999.
They combine the three amounts. Since the result, ($18,891), is an
overall loss, they enter it in column (e).
- Charles and Lily write "Activity B" on the second line
under Name of activity. Then they enter:
- ($11,600) loss in column (b) from Schedule E, line 22,
column B, and
- ($8,225) prior year unallowed loss in column (c) from their
1999 worksheets.
Then they combine these two figures and enter the total loss,
($19,825), in column (e).
- They separately add the amounts in columns (a), (b), and
(c).
- They enter $2,776 in column (a) on the "Total" line and
also on Form 8582, Part I, line 1a.
- They enter ($26,600) in column (b) on the "Total" line
and also on Form 8582, Part I, line 1b.
- They enter ($14,892) in column (c) on the "Total" line
and also on Form 8582, Part I, line 1c.
- They combine lines 1a, 1b, and 1c, Form 8582, and put the
net loss, ($38,716), on line 1d.
Worksheet 2.
Because Partnership #1 and Partnership #4 are nonrental passive
activities, Charles and Lily enter the appropriate information on
Worksheet 2 similar to the way they reported their rental activities
on Worksheet 1. Then they enter the totals on Form 8582, Part I, lines
2a through 2d.
Reporting income from column (d), Worksheets 1 and 2.
Activities that have an overall gain in column (d) are not used any
further in the calculations for Form 8582. At this point, all income
and losses from those activities should be entered on the forms or
schedules that would normally be used. Charles and Lily have one
activity with an overall gain ($4,000 - $2,600 = $1,400). This
is Partnership #1, which is shown in Worksheet 2. They already
reported the $4,000 income from this activity on Part II, Schedule E.
They now enter the entire $2,600 loss on Schedule E as well.
Step Three--Completing
Form 8582
Next, Charles and Lily complete Part II, Form 8582, to determine
the amount they can deduct for their net losses from real estate
activities with active participation (Activities A and B). They enter
all amounts as though they were positive (without brackets around
losses). They then complete Part III of Form 8582.
- They enter $38,716 on line 4 since this is the smaller of
line 1d or line 3.
- They enter $150,000 on line 5 since they are married and
filing a joint return.
- They enter $138,655, their modified adjusted gross income,
on line 6. (See the instructions for Form 8582 for a discussion of
modified adjusted gross income.) The $138,655 is made up of their
wages, $132,000, plus their overall gain of $11,655 from Partnership
#2, a PTP, plus their $5,000 overall loss from Partnership #3.
On Schedule D, they reported long-term gains of $15,300 from the
PTP disposition and $4,000 from the Partnership #3 disposition. Also,
on Schedule E they combined the PTP 2000 loss of $1,200 with its prior
year loss of $2,445, and combined the Partnership #3 2000 loss of
$6,000 with its prior year loss of $3,000. Netting these amounts gives
them the PTP overall gain of $11,655 ($15,300 - $1,200 -
$2,445) and the Partnership #3 overall loss of $5,000 ($4,000 -
$6,000 - $3,000) that were used in figuring modified adjusted
gross income.
- They subtract line 6 from line 5 and enter the result,
$11,345, on line 7.
- They multiply line 7 by 50% and enter the result, $5,673, on
line 8. No matter what the result, they cannot enter more than $25,000
on line 8.
- They enter the smaller of line 4 or line 8, $5,673, on line
9.
- They add the income on lines 1a and 2a and enter the result,
$6,776, on line 10.
- They add lines 9 and 10 and enter the result, $12,449, on
line 11.
Step Four--Completing Worksheet 3
Charles and Lily must complete Worksheet 3 since they entered an
amount on line 9 of Form 8582 and have two activities, each with an
overall loss in column (e) of Worksheet 1. Worksheet 3 allocates the
amount on line 9 (their special allowance for active participation
rental real estate activities) between Activity A and Activity B.
- In the two left columns, they write the names of the
activities, A and B, and the schedule the activities are reported on,
Schedule E.
- They fill in column (a) with the losses from Worksheet 1,
column (e). They add up the amounts, and enter the result, $38,716, in
the "Total" line without brackets.
- They figure the ratios for column (b) by dividing each
amount in column (a) by the amount on the column (a) Total
line. They enter each result in column (b). The total of the
ratios must equal 1.00.
- They multiply the amount from line 9, Form 8582, $5,673, by
each of the ratios in Worksheet 3, column (b) and enter the results on
the appropriate line in column (c). The total must equal $5,673.
- They subtract column (c) from column (a) and enter each
result in column (d).
Step Five--Completing Worksheet 4
Worksheet 4 must be completed if any activity has an overall loss
in column (e) of Worksheet 2 or a loss in column (d) of Worksheet 3
(or column (e) of Worksheet 1 if Worksheet 3 was not needed). This
worksheet allocates the unallowed loss among the activities with an
overall loss. Charles and Lily fill out Worksheet 4 with the
activities from Worksheet 3 and the one activity showing a loss in
Worksheet 2, column (e). They fill in the names of the activities and
the schedules or forms on which each loss will be reported in the two
left columns of Worksheet 4.
- In column (a), they enter the losses from Worksheet 2,
column (e) and Worksheet 3, column (d). These losses are entered as
positive numbers, not in brackets. They add the numbers and enter the
total, $36,943, on the Total line.
- They divide each of the losses in column (a) by the amount
on the column (a) Total line, and enter each result in
column (b). The ratios must total 1.00.
- Now they use the computation worksheet for column (c) (see
Worksheet 4 in the instructions for Form 8582) to figure
the unallowed loss to allocate in column (c).
- On line A of the computation worksheet, they enter the
amount from line 3 of Form 8582, $41,216, as a positive number.
- On line B, they enter the amount from line 9 of Form 8582,
$5,673.
- They subtract line B from line A and enter the result,
$35,543, on line C. This is the total unallowed loss.
They multiply line C, $35,543, by each of the ratios in column
(b) and enter the results in column (c). These amounts are the
unallowed loss from each activity and must add up to $35,543.
Step Six--Using
Worksheets 5 and 6
Charles and Lily now decide whether they must use Worksheet 5,
Worksheet 6, or both to figure their allowed losses. If the loss from
any activity entered on Worksheet 4 is reported on only one form or
schedule, then Worksheet 5 is used for that activity. If an activity
has a loss that is reported on two or more schedules or forms (for
example, a loss that must be reported partly on Schedule C and partly
on Form 4797) or on different parts of the same form or schedule (for
example, 28%-rate and non-28%-rate capital losses reported in Part II
of Schedule D), Worksheet 6 is used for that activity. All of the
activities Charles and Lily entered on Worksheet 4 will be reported on
Schedule E. Therefore, they use Worksheet 5 to figure the allowed loss
for each activity. (Worksheet 6 is not shown here.)
Worksheet 5.
They fill out Worksheet 5 with the activities from Worksheet 4.
- They enter the names of the activities and the schedules to
be used in the two left columns of Worksheet 5.
- In column (a), they enter the total loss for each activity.
This includes the current year loss plus the prior year unallowed
loss. They find these amounts by adding columns (b) and (c) on
Worksheets 1 and 2.
- In column (b), they enter the unallowed loss for each
activity already figured in Worksheet 4, column (c). They must save
this information to use next year in figuring their passive losses.
- In column (c), they figure their allowed losses for 2000 by
subtracting their unallowed losses, column (b), from their total
losses, column (a). These allowed losses are entered on the
appropriate schedules.
Reporting allowed losses.
Charles and Lily enter their allowed losses from Activities A and B
on Schedule E, Part I, line 23, because these are rental properties.
They report their allowed loss from Partnership #4 on Schedule E, Part
II.
Step Seven--Finishing the Reporting of the Passive
Activities
Charles and Lily summarize the entries on Schedule E, Schedule D,
and Form 4797, and enter the amounts on the appropriate lines of their
Form 1040. They enter:
- The total Schedule D gain, $22,076, on line 13, and
- The Schedule E loss, ($21,094), on line 17.
Charles and Lily are now able to complete their tax return, having
correctly limited their losses from their passive activities.
Form 1040, page 1
Schedule D (Form 1040), page 1
Schedule E (Form 1040), page 1
Schedule E (Form 1040), page 2
Form 4797, page 1
Form 8582
Worksheets 1--5 for Form 8582
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