Mutual Funds Uni Trusts REITS

<div class="Section1"><br /> <p>The “at risk” rules apply to each of the following activities when engaged in by an individual (including partners and S corporation shareholders) as a trade or business or for the production of income:</p><br /> <p>…holding, producing, or distributing motion picture films or video tapes;</p><br /> <p>…farming (including raising, shearing, feeding, caring for, training, or management of animals);</p><br /> <p>…leasing of depreciable personal property (and certain other “IRC Section 1245” property, which includes both real and personal property and certain other tangible property that is being, or has been depreciated or amortized<a href="#_ftn1" name="_ftnref1">¹</a>);</p><br /> <p>…exploring for, or exploiting, oil and gas reserves (see <a class="accordion-cross-reference" href="https://www.thinkadvisor.com/tax-facts/2024/03/13/7857-how-do-individuals-invest-in-oil-and-natural-gas/">Q 7857</a> to <a class="accordion-cross-reference" href="https://www.thinkadvisor.com/tax-facts/2024/03/13/7887-what-items-of-tax-preference-for-purposes-of-the-alternative-minimum-tax-are-unique-to-an-oil-and-gas-program/">Q 7887</a>);</p><br /> <p>…exploring, or exploiting, geothermal deposits;</p><br /> <p>…holding real property (see <a class="accordion-cross-reference" href="https://www.thinkadvisor.com/tax-facts/2024/03/13/7792-does-the-at-risk-limitation-on-losses-apply-to-an-investor-in-real-estate-if-so-what-effect-will-it-have/">Q 7792</a> for effective date and transitional relief rules);</p><br /> <p>…all other activities engaged in by a taxpayer in carrying on a trade or business or for the production of income.<a href="#_ftn2" name="_ftnref2">²</a></p><br /> <p>Apparently, if a publicly traded partnership is taxed as a corporation (see ), the partnership is not subject to the at risk rules unless it is closely-held (generally, more than 50 percent control by five or fewer individuals).<a href="#_ftn3" name="_ftnref3">³</a> For these purposes, a qualified retirement plan described in IRC Section 401(a) as well as a plan providing for the payment of unemployment compensation benefits under IRC Section 501(c)(17) are considered individuals.<a href="#_ftn4" name="_ftnref4">⁴</a></p><br /> </div><br /> <div class="refs"><br /> <hr align="left" size="1" width="33%"><br /> <p><a href="#_ftnref1" name="_ftn1">1</a>. IRS Publication 925, Passive Activity and At-Risk Rules.</p><br /> <p><a href="#_ftnref2" name="_ftn2">2</a>. IRC §§ 465(c), 464(e).</p><br /> <p><a href="#_ftnref3" name="_ftn3">3</a>. See IRC § 465(a).</p><br /> <p><a href="#_ftnref4" name="_ftn4">4</a>. IRC § 542(a)(2).</p><br /> </div>

<div class="Section1"><br /> <p>Under the passive loss rules, aggregate losses from “passive” activities (see <a href="javascript:void(0)" class="accordion-cross-reference" id="8011">Q 8011</a>) may generally be deducted in a year only to the extent they do not exceed aggregate income from passive activities in that year; credits from passive activities may be taken against tax liability allocated only to passive activities.<a href="#_ftn1" name="_ftnref1">¹</a> (Aggregation is not permitted in the case of certain publicly traded partnerships. See below.) The rules generally apply to losses incurred in tax years beginning after 1986. The rules are intended to prevent losses from passive activities from offsetting salaries, interest, dividends, and income from “active” businesses. They apply to individuals, estates, trusts, closely held C corporations, and personal service corporations.</p><br /> <p>An <em>individual</em> can also deduct a limited amount of losses (and the deduction-equivalent of credits) arising from certain rental real estate activities against nonpassive income. See <a href="javascript:void(0)" class="accordion-cross-reference" id="8021">Q 8021</a>. A <em>closely held C corporation</em> (other than a personal service corporation) can deduct its passive activity losses against its net active income (other than its investment, or “portfolio,” income) and its passive credits can be applied against its tax liability attributable to its net active income.<a href="#_ftn2" name="_ftnref2">²</a> Generally, a corporation is “closely” held if five or fewer individuals own more than 50 percent of the value of the stock.<a href="#_ftn3" name="_ftnref3">³</a> (For these purposes, certain organizations—including a qualified retirement plan under IRC Section 401(a) and a trust providing for the payment of supplemental unemployment compensation benefits under IRC Section 501(c)(17)—are considered an “individual.”)<a href="#_ftn4" name="_ftnref4">⁴</a> A personal service corporation is a corporation the principal activity of which is the performance of personal services and the services of which are substantially performed by employee-owners.<a href="#_ftn5" name="_ftnref5">⁵</a></p><br /> <p>An exception to the passive loss restrictions is applied to certain casualty losses resulting from unusual events such as fire, storm, shipwreck, and earthquake. Losses from such casualties are generally not subject to the passive loss rules.<a href="#_ftn6" name="_ftnref6">⁶</a> Likewise, passive activity income does not include reimbursements for such losses if (1) the reimbursement is includable in gross income under Treasury Regulation Section 1.165-1(d)(2)(iii) as an amount the taxpayer had deducted in a prior taxable year, and (2) the deduction for the loss was not a passive activity deduction. In other words, both the losses and the reimbursement should be taken into account in the calculation of the partnership’s gross income, not its passive activity gross income.<a href="#_ftn7" name="_ftnref7">⁷</a> The exception does not apply to losses that occur regularly in the conduct of the activity, such as theft losses from shoplifting in a retail store, or accident losses sustained in the operation of a rental car business.<a href="#_ftn8" name="_ftnref8">⁸</a></p><br /> <p>Special restrictions apply to <em>publicly traded partnerships</em> under the passive loss rules. The rules are applied separately to items attributable to a publicly traded partnership; thus, income, losses, and credits attributable to the partnership may not be aggregated with other income, losses, and credits of the taxpayer/partner for purposes of the passive loss rules.<a href="#_ftn9" name="_ftnref9">⁹</a> Net passive loss from a publicly traded partnership will be treated as passive, while net passive income from a publicly traded partnership is to be treated as investment income. See <a href="javascript:void(0)" class="accordion-cross-reference" id="8040">Q 8040</a>.<a href="#_ftn10" name="_ftnref10">¹⁰</a> Generally, net passive loss from a publicly traded partnership is carried forward until the partner has additional passive income from the partnership or the partner disposes of the partnership interest. See <a href="javascript:void(0)" class="accordion-cross-reference" id="8019">Q 8019</a>.Also, the $25,000 rental real estate exemption (see <a href="https://prod-taxfacts-alm.content.pugpig.com/faqs_page/limitation-on-loss-deductions/pugpig_index.html#faq-8021">Q 8021</a>) is available with respect to a publicly traded partnership only in connection with the low-income housing credit (see <a href="javascript:void(0)" class="accordion-cross-reference" id="7808">Q 7808</a>) and the rehabilitation investment credit. See <a href="https://prod-taxfacts-alm.content.pugpig.com/faqs_page/real-estate/pugpig_index.html#faq-7808">Q 7808</a>.Furthermore, a taxpayer will not be treated as having disposed of the taxpayer’s entire interest in an activity of a publicly-traded partnership until disposition of the entire interest in the partnership. A publicly traded partnership is a partnership that is traded on an established securities market or is readily tradable on a secondary market (or the substantial equivalent thereof).<a href="#_ftn11" name="_ftnref11">¹¹</a> It would seem that if a publicly traded partnership is taxed as a closely held C corporation or any personal service corporation (see ), the partnership is not a taxpayer subject to the passive loss rules.<a href="#_ftn12" name="_ftnref12">¹²</a></p><br /> <p>Losses and credits disallowed under the passive loss rules may be carried over to offset passive income and the tax attributable to it in later years. See <a href="javascript:void(0)" class="accordion-cross-reference" id="8019">Q 8019</a>. Suspended losses and credits of an activity may also offset the income and tax of that activity when the activity ceases to be passive or there is a change in status of a closely held corporation or personal service corporation. See <a href="javascript:void(0)" class="accordion-cross-reference" id="8020">Q 8020</a>.As to losses allowed upon disposition of an interest in a passive activity, see <a href="https://prod-taxfacts-alm.content.pugpig.com/faqs_page/limitation-on-loss-deductions/pugpig_index.html#faq-8019">Q 8019</a>.</p><br /> <p>The passive loss rules apply to passive losses incurred in tax years beginning after 1986. They do not apply to any loss or credit carried over from a year beginning before 1987.<a href="#_ftn13" name="_ftnref13">¹³</a> A taxpayer may elect to treat investment interest (see <a href="javascript:void(0)" class="accordion-cross-reference" id="8040">Q 8040</a>) as a passive activity deduction if the interest was carried over from a year prior to 1987 and is attributable to property used in a passive activity after 1986.<a href="#_ftn14" name="_ftnref14">¹⁴</a> However, the interest deduction is not treated as being from a pre-enactment interest in a passive activity.<a href="#_ftn15" name="_ftnref15">¹⁵</a> This election had to be made by filing an amended return on or before the later of (1) the due date (taking into account any extensions of time to file obtained by the taxpayer) for filing the income tax return of the taxpayer for the taxpayer’s first taxable year beginning after December 31, 1987, or (2) August 15, 1989.<a href="#_ftn16" name="_ftnref16">¹⁶</a></p><br /> </div><br /> <div class="refs"><br /> <hr align="left" size="1" width="33%"><br /> <p><a href="#_ftnref1" name="_ftn1">1</a>. IRC § 469.</p><br /> <p><a href="#_ftnref2" name="_ftn2">2</a>. IRC § 469(e)(2).</p><br /> <p><a href="#_ftnref3" name="_ftn3">3</a>. IRC § 469(j)(1).</p><br /> <p><a href="#_ftnref4" name="_ftn4">4</a>. IRC § 542(a)(2).</p><br /> <p><a href="#_ftnref5" name="_ftn5">5</a>. IRC § 469(j)(2).</p><br /> <p><a href="#_ftnref6" name="_ftn6">6</a>. Temp. Treas. Reg. § 1.469-2T(d)(2), Treas. Reg. § 1.469-2(d)(2)(xi).</p><br /> <p><a href="#_ftnref7" name="_ftn7">7</a>. Temp. Treas. Reg. § 1.469-2T(c)(7), Treas. Reg. § 1.469-2(c)(7)(vi).</p><br /> <p><a href="#_ftnref8" name="_ftn8">8</a>. TD 8290, 1990-1 CB 109.</p><br /> <p><a href="#_ftnref9" name="_ftn9">9</a>. IRC § 469(k)(1).</p><br /> <p><a href="#_ftnref10" name="_ftn10">10</a>. Notice 88-75, 1988-2 CB 386.</p><br /> <p><a href="#_ftnref11" name="_ftn11">11</a>. IRC § 469(k).</p><br /> <p><a href="#_ftnref12" name="_ftn12">12</a>. See IRC § 469(a).</p><br /> <p><a href="#_ftnref13" name="_ftn13">13</a>. TRA ’86 § 501(c)(2).</p><br /> <p><a href="#_ftnref14" name="_ftn14">14</a>. TAMRA ’88 § 1005(c)(11).</p><br /> <p><a href="#_ftnref15" name="_ftn15">15</a>. Notice 89-36, 1989-1 CB 677.</p><br /> <p><a href="#_ftnref16" name="_ftn16">16</a>. TAMRA ’88 § 1005(c)(11; Notice 89-36, 1989-1 CB 6771.</p><br /> </div>

<div class="Section1"><br /> <p class="PA">A money market fund is a mutual fund generally seeking maximum current income and liquidity through investment in short-term money market instruments, such as Treasury bills, certificates of deposit, or commercial paper. Dividends are customarily declared daily, and automatically reinvested in additional shares, unless a distribution option is elected. Shares may be redeemed at any time.</p><br /> <br /> </div><br />

<div class="Section1"><br /> <p class="PA">A closed-end fund holds a portfolio of investment assets, but does not ordinarily redeem shares at net asset value or sell new shares. Shares of the fund itself are actively traded on the secondary market.</p><br /> <p class="PA">Although a closed-end fund is not actually a mutual fund, if the fund qualifies and makes the necessary election to be taxed as a regulated investment company (RIC), its shareholders will be taxed like shareholders of a mutual fund. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7938">7938</a> through Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7951">7951</a> for details. If, on the other hand, the closed-end fund is established as a regular corporation, its shareholders will be taxed accordingly (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7501">7501</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7540">7540</a>).</p><br /> <p class="PA">Because closed-end fund shares are traded in the open market or on an exchange and are not redeemed by the company, capital gain or loss on sale is based on the sale price and not on redemption price.</p><br /> <p class="PA">See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7922">7922</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7935">7935</a> for a discussion of RICs and their tax treatment.</p><br /> <br /> </div><br />

<div class="Section1"><br /> <p class="PA">Most currency ETFs are formed as grantor trusts. This means the profit from the trust creates ordinary income tax liability for the individual ETF shareholder based on the rules that apply to grantor trusts. As a result, currency ETFs are not eligible for favorable long-term capital gains treatment, even if the ETF is held for several years. Since currency ETFs trade in currency pairs, the taxing authorities assume that these trades take place over short periods of time.</p><br /> <br /> </div><br />

<div class="Section1">If an activity ceases to be passive (e.g., because the taxpayer begins to participate materially), its unused losses (or credits) from prior years continue to be passive, but may be used against the income (and tax liability) of that activity. If there is a change in the status of a closely held C corporation or personal service corporation, its suspended losses from prior years will continue to be treated as if the status of the corporation had not changed.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> As a general rule, an individual will be treated as materially participating in an activity for the taxable year if, and only if, he or she participates in the activity for more than 500 hours during the year, or if his or her participation satisfies one of six other requirements in Temporary Treasury Regulation Section 1.469-5T(a). For instance, the individual&rsquo;s participation will be deemed material if, based on all of the facts and circumstances, the individual participates in the activity on a regular, continuous, and substantial basis during such year.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <hr><br /> <br /> For an explanation of losses allowed upon disposition of an interest in a former passive activity, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8019">8019</a>.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 469(f).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. Temp. Treas. Reg. &sect; 1.469-5T(a)(7).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> In addition to meeting the asset-based tests described in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7986">7986</a>, a REIT must satisfy several diversification tests with respect to its assets in order to qualify for pass-through tax treatment as a REIT. The following diversification tests are applied at the close of each quarter of each taxable year of a REIT&rsquo;s existence:<br /> <ol><br /> <li>No more than five percent of the value of a REIT&rsquo;s total assets may consist of securities of any one issuer (except with respect to taxable REIT subsidiaries (TRS) and securities permitted under the 75 percent test).</li><br /> <li>A REIT may not hold securities that represent more than 10 percent of the voting power of the outstanding securities of any one issuer.</li><br /> <li>A REIT may not hold securities that represent more than 10 percent of the total value of the outstanding securities of any one issuer.<a href="#_ftn1" name="_ftnref1">¹</a></li><br /> </ol><br /> The IRC recognizes that the value of securities may fluctuate between quarters. As such, Section 856 provides that if a REIT meets the diversification requirements at the close of any given quarter, it will not fail to meet the requirements in the subsequent quarter unless the failure is due to the acquisition of securities or property and is wholly or partially the result of that acquisition. If a REIT fails to meet the diversification tests at the close of a quarter as a result of an acquisition of securities made during that quarter, it has a 30-day period in which to correct the discrepancy. If the discrepancy is corrected within that 30-day period, the REIT will be treated as having satisfied the diversification test for the quarter.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 856(c)(4)(B)(iii).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 856(c)(4).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <p class="PA">Individual taxpayers who trade or invest in gold, silver, or platinum bullion are subject to the IRS&rsquo; rules that govern &ldquo;collectibles&rdquo; for tax purposes. The same rules apply to ETFs that trade or hold gold, silver, or platinum. Under the rules that apply to collectibles, if gain is short-term, it is taxed as ordinary income. If gain is earned over a period that spans more than one year, then it is taxed at one of three capital gains rates, depending on the taxpayer&rsquo;s income tax bracket. This means that taxpayers cannot take advantage of the normal capital gains tax rates on investments in ETFs that invest in gold, silver, or platinum. The ETF provider will specify what is considered short-term and what is considered long-term gain or loss.</p><br /> <br /> </div><br />

<div class="Section1"><br /> <br /> A qualified REIT subsidiary is a corporation in which the REIT owns 100 percent of the interests&mdash;e.g., it is a wholly owned subsidiary of a REIT. A qualified REIT subsidiary is not treated as an entity separate from the parent-REIT, so that all of the income and assets of the subsidiary are considered along with the REIT&rsquo;s for purposes of the REIT income and asset tests.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> A subsidiary that has elected to be treated as a taxable REIT subsidiary (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7999">7999</a>) cannot qualify as a qualified REIT subsidiary.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> If a qualified REIT subsidiary ceases to be 100 percent wholly-owned by the parent-REIT, its status as a qualified REIT subsidiary is terminated and it is treated as a new corporation that acquired all of its assets from the parent-REIT in exchange for its stock.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 856(i)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 856(i)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect; 856(i)(3).<br /> <br /> </div></div><br />

<div class="Section1">ETFs have several advantages over mutual funds, including the following:<br /> <ul><br /> <li>They are easy to trade: they can be bought and sold anytime through any broker, just like a stock.</li><br /> <li>They are tax efficient: ETFs typically have lower portfolio turnover and strive to minimize capital gains distributions so that investors are only taxed when they initiate a trade. Note: There are special rules for currency, commodity, and metals ETFs that cause them to be taxed in the same way as the underlying class of investment (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7959">7959</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7962">7962</a>).</li><br /> <li>Greater Transparency: ETFs disclose the exact holdings of their funds on a daily basis so the investor always understands precisely what he or she owns.</li><br /> <li>Flexibility: Any action that an investor can take with respect to stock can be accomplished with an ETF. This includes shorting and holding ETFs in margin accounts and placing limit orders.</li><br /> </ul><br /> </div><br />