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I would like to correct a statement by Margaret Conway which appeared in the Estate and Trusts section of the July 1996 issue of The CPA Journal. On the whole, her article, entitled "Passive Activity Loss Rules to Remember for Decedents & Estates," was a good summary of the rules in this area, for which we have had virtually no guidance from the Treasury or the IRS since the 1986 TRA was enacted 10 years ago. However, her discussion of the consequences of distributions by estates of passive activities is flawed. She states flatly when such distributions are made suspended passive activity losses (PALs) they cannot pass through to the beneficiaries. This is only partially correct; it may be true in some cases but not in many.

Ms. Conway bases her statement on IRC Sec. 469(j)(12) which provides that the basis of the passive activity interest distributed shall be increased by any PALs applicable to such interest. However, she has overlooked the provisions of IRC Sec. 469(g)(1) which, in my firm opinion, governs many such distributions by executors. Sec. 469(g)(1) is the general rule which provides that suspended PALs arising from a particular passive activity will be "triggered" (converted into an ordinary business loss fully deductible against nonpassive income) in the year in which any taxpayer disposes of his entire interest in the activity in a fully taxable transaction, unless the disposition involves a related party. Although a trustee and a trust beneficiary are related parties, an executor and an estate beneficiary are not.

There is no question that distributions by an executor to fund a true worth formula pecuniary bequest [(Regs. Sec. 1.1014-4(a)(3)] and distributions to fund a residuary or fractional bequest when an executor makes an affirmative Sec. 643(e) election to realize a gain or loss are fully taxable transactions.

It is clear, therefore, that the special limitation of Sec. 469(j)(12) becomes operative only when an interest in a passive activity is distributed by an estate to a beneficiary and the general rules of nonrecognition of gain or loss on property distributions by--

l. distributions to fund specific bequests.

2. distributions to fund residuary or fractional bequests when the executor does not make a Sec. 643(e)(3) election to recognize a loss.

3. distributions to fund certain types of fixed-dollar bequests that are not treated as fully taxable transactions (e.g., to satisfy a fairly representative or a minimum worth formula pecuniary bequest).

For a more comprehensive discussion (and examples) of the governing rules in this area, readers are referred to my article, "Planning for the Vanishing Suspended PAL of Decedents and Executors," Trusts & Estates, February 1992, p. 8, which still remains valid. *

Bernard Barnett
BDO Seidman

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