Magazine article The CPA Journal

Planning for Distributions of Passive Activities by Estates

Magazine article The CPA Journal

Planning for Distributions of Passive Activities by Estates

Article excerpt

A significant planning opportunity exists for utilizing suspended losses accumulated during the administration of an estate. We all know that if a passive activity is sold to an unrelated party, its suspended losses become deductible. What happens if the activity is not sold and it is instead distributed to a beneficiary of an estate?

THE RULES

Generally, when an estate or trust distributes property (other than in satisfaction of a pecuniary amount), no gain or loss is recognized on the distribution. In such an instance, there is a carryover of the property's basis from the fiduciary to the beneficiary.

If an estate or trust distributes a passive activity to a beneficiary, the suspended losses attributable to the activity are not deductible at such time. Rather, the must be added to the basis of the activity [IRC Sec. 469(j)(l2)] or, practically speaking, they are capitalized. Therefore, the beneciary will never be able to deduct those losses as such. The benefit of those losses will instead be reflected in the computation of gain or loss recognized upon the ultimate disposition of the activity by the beneficiary.

Example. The estate of John B. Jones owns an interest in S corporation XYZ. On July 2, 1993, the estate has a basis of $50,000 and suspended losses of $20,000. If the estate distributes the interest in XYZ to a beneficiary of the estate on that day, the beneficiary's basis will be $70,000, with no suspended losses.

THE IRC SEC. 643(E)(3) ELECTION

For noncash property distributions, a fiduciary may elect to have the estate or trust recognize gain or loss in the same manner as if the distributed property had been sold to the beneficiary at its fair market value. The election applies to all distributions made during the tax year [IRC Sec. 643(e)(3)1. As a result of the election, the beneficiary's basis in the property is its fair market value rather than the estate or trust's basis (as adjusted by any suspended losses). Since a trust and a beneficiary of a trust are considered related parties [IRC Sec. 267(b)(6)1 the following restrictions apply (only to trusts):

1. The trust will not be permitted to recognize any loss resulting from an IRC Sec. 643(e)(3) election. A beneficiary receiving a distribution from a trust that incurred a nondeductible loss due to the limitations imposed by the related party rules may be allowed to deduct the loss upon disposition of the property. If the beneficiary disposes of the property at a gain, he or she can deduct the loss to the extent of but not in excess of the gain. [IRC Sec. 267(d)1

2. If a trust distributes depreciable property, IRC Sec. 1239 denies any capital gain treatment on the distribution if the IRC Sec. 643(e)(3) election is made.

Since assets generally do not appreciate significantly during the administration of an estate, the potential for recognizing a substantial gain by making the election will generally not be that significant. But why would the estate want to recognize any gain at all?

THE BENEFITS OF ELECTION

Under IRC Sec. 469(g)(1), if a taxpayer disposes of his entire interest in a fully taxable transaction, any suspended losses attributable to such interest become deductible in the year of the disposition. Under IRC Sec. 643(e)(3), the distribution is considered to be a sale for income tax purposes. …

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