Category: Individuals; Partnerships & LLCs
Subject: Passive Activity, Disposition of
Title: Assignment as Complete Disposition
IRC Sections: 469(g), 172
Filename: 1205.html
Date Produced: 02/95

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Facts
Individual taxpayer (TP) owns an interest in a limited partnership (LP) engaged in the business of selling timeshare units. TP is a limited partner. LP incurred significant operating losses in the years 1991 through 1993 which of course are passive losses to TP. In 1994, LP's lender foreclosed on the partnership's property. During 1994, TP formally assigned his partnership interest in LP to the other partners.

Issues
1. Does the assignment constitute a complete disposition of the passive activity by TP?

2. If so, is the resulting freed-up passive loss eligible to produce a net operating loss for TP?

Answers
1. Assuming that TP has no further interest in either the partnership or any of its activities, the assignment constitutes a complete disposition for purposes of the passive activity rules.

2. The freed-up passive loss is eligible to produce a net operating loss for TP.

Discussion: Issue 1
Under Section 469(g), if a taxpayer disposes of his entire interest in any passive activity in a fully taxable transaction (i.e., one in which all realized gains or losses are recognized), any excess losses from the activity may be utilized to offset nonpassive income. There are two requirements set forth in the statute: 1) disposition in a fully taxable transaction; and 2) disposition of the taxpayer's entire interest.
There is no question that assignment of a partnership interest is a fully taxable event. The only question is whether TP has disposed of all his interest in the partnership. In order to do so, TP must dispose of all his partnership interest(s) as well as any interest, either direct or through some other entity, in the activities conducted by LP.

First, it is assumed that TP's interest in LP is as a limited partner only. Disposition of TP's limited partner interest would not be a complete disposition if TP also owned a GP interest as well. Second, TP cannot have any other interest in the activities of LP, even an interest held outside the partnership. For example, if TP were involved in some other entity which holds an interest in the activities of LP, then disposition of TP's limited partnership interest would not be a complete disposition. BNA Tax Management Portfolio 454-2nd provides the following example.

Taxpayer T owns a limited partnership interest in Partnership P, which conducts two passive activities. T can dispose of his interests in both activities by selling his entire interest in P. Alternatively, if P sells all assets used in one of the activities, T is treated as having disposed of that activity. If one of the activities is conducted jointly by P and Partnership Q, Q must dispose of all assets used in that activity as well (or T must dispose of his interest in Q) in order for the disposition rule to apply.

Discussion: Issue 2
Under Section 469(g), any loss representing the sum of the suspended passive losses from a completely disposed activity plus any loss recognized on the disposition of the activity plus or minus any income or loss generated by that activity in the year of disposition is first offset against the taxpayer's disposition year passive income from other sources. Any remaining loss is then treated as a loss from other than a passive activity.

Section 172 allows a noncorporate taxpayer to carry back and carry over net operating losses; however, the law requires a number of modifications from taxable income in determining the net operating loss available for carry back or carry over. The noncorporate taxpayer is allowed to include nonbusiness deductions as part of the net operating loss only to the extent of nonbusiness income. Accordingly, if the losses related to TP's investment in LP were considered nonbusiness, such losses would not increase TP's net operating loss; rather, these losses would only be allowed to reduce nonbusiness income down to zero.

The issue then becomes whether a loss from a partnership is deemed to be a business or nonbusiness deduction for purposes of the net operating loss rules. Provided that the partnership is itself engaged in a trade or business (which LP presumably is), it is clear that losses from such partnerships are considered business losses for purposes of the net operating loss rules. See Pierce v. U.S., 254 F.2d 885, 58-1 USTC ¶9470 (9th Cir. 1958). Accordingly, the suspended passive losses from LP would be eligible to produce a net operating loss for TP.

Other Relevant Matters
TP may have a capital loss if there is any basis remaining in his partnership interest. Care should be taken in dealing with the limitations on capital losses under Section 1211 and the interaction of capital losses with the net operating loss computational rules.