Gifts of passive activities may yield a surprising result. (Estates & Trusts)by Svagna, Marco
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(j)(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 hav in essence been capitalized, the donee will never be able to deduct those losse 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 o a smaller capital gain (or larger capital loss).
When Basis Exceeds 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 th 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.
What is the Real Basis?
Depending on the particular fact pattern, this could pose some interesting problems. What happens if after adding the suspended losses to the donor's basi the adjusted basis now exceeds fair market value? Note how IRC Sec. 469(j)(6)(A is drafted:
(6) Special Rule for Gifts--In the case of a disposition of any interest in a passive activity by gift--
(A) The basis of such interest immediately before the transfer shall be increased by the amount of any passive activity losses allocable to such interest...
As previously discussed, the donee's basis in a gifted asset is carried over from the donor. But what is the donor's true basis in the passive activity at the time of the gift? Based upon a literal reading of IRC Sec. 469(j)(6)(A), th statute requires that the basis immediately before the transfer be increased by any suspended losses. Therefore, the donor's basis (and, accordingly, the carryover basis to the donee) at the precise moment the transfer takes place includes any suspended losses. This conclusion is supported by the Senate Finance Committee Report (Act IRC Sec. 501) which states the following at footnote 12:
For purposes of determining the donee's loss in a subsequent transaction, however, the donee's basis may not exceed the fair value of the gift at the tim he received it |IRC Sec. 1015(a).
Note that the statement focuses in on the donee's basis at the time of the gift rather than on the donor's. Obviously, the donee's basis already includes the donor's suspended losses.
Example. Stan Smith owned an interest in ABC, L.P. On January 1, 1993, his basi in the partnership was $100,000 with suspended losses of $50,000. The fair market value of the partnership interest on that day was $110,000. Stan made a gift of the interest to his brother Joe on January 1, 1993. Joe's basis would b $150,000 ($100,000 plus $50,000). On January 2, 1993, Joe decides to sell the partnership interest for $115,000.
How does Joe report this transaction on his 1993 income tax return? Does he hav a capital loss of $35,000 ($115,000 minus $150,000)? If we follow a literal interpretation of the statute as discussed above wherein the donor's basis at the time of transfer is deemed to be $150,000, under IRC Sec. 1015(a) Joe will report neither a loss nor gain on the transaction. This is due to the fact that since the donor's basis exceeded fair market value, the special rules discussed above apply. Because the interest was sold for a price ($115,000) between the donor's basis ($150,000) and the fair market value ($110,000) at the time of th gift, neither a gain nor loss is recognized.
This seems to be a harsh result which may surprise the unexpecting. Hopefully, when regulations are eventually issued, they will address this matter.
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