Gifts of Passive Activities May Yield a Surprising Result

By Svagna, Marco | The CPA Journal, March 1994 | Go to article overview

Gifts of Passive Activities May Yield a Surprising Result


Svagna, Marco, The CPA Journal


Even though we have completed the sixth filing season since the enactment of the Tax Reform Act of 1986, we are still awaiting regulations addressing the application of the passive loss rules to estates, trusts, and gifts. While the statute [IRC Sec. 469] itself provides a good deal of guidance, questions remain. One such question arises when passive activities are transferred by gift.

GENERAL RULE

When an activity with suspended losses is transferred by gift, the basis of the activity to the donee will be the donor's basis plus any suspended losses [IRC Sec. 469(i)(6)] and the portion of any gift tax [IRC Sec. 1015(d)(6)] and generation skipping transfer tax [IRC Sec. 2654(a)(1)] paid on the transfer attributable to the appreciation in the activity. The basis as adjusted cannot exceed the fair market value. Therefore, since the donor's suspended losses have in essence been capitalized, the donee will never be able to deduct those losses as such. The benefit of those losses will instead be reflected in the computation of the gain or loss recognized upon the disposition of the activity.

Example. John A. Donor owned an interest in partnership XYZ. On January 1, 1993, his basis in the partnership was $30,000 with suspended passive losses of $15,000. The fair market value of the partnership interest on that day was $70,000. If John made a gift of the interest to his brother Steve on January 1, Steve's basis will be $45,000 ($30,000 plus $15,000), assuming no gift tax was required to be paid (due to the availability of the unified credit by John). Steve will not be able to utilize any of John's suspended losses, but will instead realize a benefit upon disposition of his interest in XYZ in the form of a smaller capital gain (or larger capital loss).

WHEN BASIS EXCEED FAIR MARKET VALUE

If the donor's basis in the property at the time of the gift exceeds its fair market value, any gain or loss resulting from a subsequent disposition of the property by the donee is computed as follows [IRC Sec. 1015(a)]:

* Gain, The basis for computing gain is the donor's basis at the time of the gift.

* Loss, The basis for determining a loss is the fair market value of the property at the time of the gift.

If the property is sold for a price between the donor's basis and its fair market value at the time of the gift, neither gain nor loss is recognized.

Example. Albert Jones acquires by gift income-producing property which has an adjusted basis of $100,000 at the date of the gift. The fair market value of the property at the date of the gift is $90,000. Mr. Jones later sells the property for $95,000. In such a case, there is neither gain nor loss. The basis for determining loss is $90,000; therefore, there is no loss. Furthermore, there is no gain, since the basis for determining gain is $100,000. …

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