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SUBJECT - Triggering suspended passive loss carry forwards

Customer Question
on MLP sales when...
SUBJECT - Triggering suspended passive loss carry forwards on MLP sales when less than all of the shares of a position are sold:
JA: The Accountant will know how to help. Please tell me more, so we can help you best.
Customer: The TurboTax interview process for reporting K-1 information makes no distinction for whether all, or only a portion, of an MLP position is sold. As a result, on my 2016 return when I entered the information showing a sale of part of an MLP position, the suspended passive loss carry forwards were sufficient to wipe out any depreciation re-capture. The result was no reportable ordinary gain. I am a stockbroker who recommended the partial sale to six taxable clients. Three, including me used TurboTax and showed no reportable ordinary gain. The others used CPA's and were told since there was only a partial sale the suspended passive loss carry forwards could not be used. The result for them was a substantial reportable ordinary gain. Whose right? If audited can I rely on the TurboTax software to protect me from an unreported ordinary gain?
JA: Is there anything else important you think the Accountant should know?
Customer: No
Submitted: 4 months ago.Category: Tax
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7/16/2017
Tax Professional: Stephen G., Sr Income Tax Expert replied 4 months ago
Stephen G.
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Hello, my name is***** goal is to give you a complete & accurate answer. I am working on your request now & I will respond as soon as possible.

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Tax Professional: Stephen G., Sr Income Tax Expert replied 4 months ago

It depends upon the nature of the Passive Activity Loss Carryforwards you are referring to. Are you referring to PAL's exclusively from the MLP that was sold at a gain, or are you referring to all PAL carryforwards from all PALs?

The CPAs appear to be going by the following from IRC 469 (g)(1)(A):

When an entire interest in a passive activity is sold to an unrelated party, current and suspended losses related to the activity may be used according to the following rules (Sec. 469(g)(1)(A)):

1. If the entire gain or loss from the sale of the property is recognized, the current-year loss from the activity (including all suspended losses) can be offset in full against any gain from disposing of the property or combined with the loss from such disposition.

2. If gain remains after item 1, it can be offset against any losses (including suspended losses) from all other passive activities. Any remaining gain is reported in the normal manner. However, any loss remaining is carried forward as a suspended passive loss.

3. If the result of item 1 is a loss, this loss can be offset against any net income or gain from all other passive activities (net of suspended losses carried from earlier years). If any of the loss from the disposed activity remains, it can then be deducted as a nonpassive loss.

From a PWC PTP NewsBytes article 4th Quarter 2014:

https://www.pwcmlp.com/ptpnewsbytes/201412.pdf

"Investors in publicly traded partnerships (“PTPs”) must be aware of the tax implications of the losses they are allocated from the ownership of a PTP. Internal Revenue Code (“IRC”) §469(k) provides that a unitholder’s allocable share of income, deduction, gain and loss from a PTP are

items from a passive activity. IRC §469(a)(1) disallows the utilization of passive activity losses (“PAL”) generated by PTPs by certain unitholders (the “PAL Rules”). Affected unitholders include individuals, estates, trusts, closely-held C corporations and personal service corporations.

Exceptions exist that afford partners who materially participate in the PTP the opportunity to classify passive losses as non-passive losses. An individual who purchases PTP units and is allocated a loss for the taxable year will not be able to use the PTP losses to offset other personal income.

1 Any disallowed losses will be carried over to the following year. When a unitholder subject to the PAL Rules disposes of an interest in the PTP, some or all of the PAL carryover may be utilized in the tax year of disposition. The rules vary depending on whether the investor partially or fully divests of their ownership in the PTP. In general, any cumulative PTP losses

(including any gain or loss on the sale) in the year of a full disposition of the PTP interest in a taxable transaction are not subject to PAL Rules.

2 Therefore, prior losses that were disallowed and any current year gains or losses will be claimed on the unitholder’s tax return. In contrast, the partial sale of a PTP interest does not nullify the application of PAL Rules to unitholder’s previously disallowed losses. Gain from the partial disposition of a PTP interest is treated as gain from the PTP. Therefore, any gain generated by the partial disposition can be offset by previously disallowed PALs from that PTP. Any excess disallowed PALs after offsetting the gain will continue to carry over to subsequent tax years. It is important to remember that IRC §469(k) applies on a PTP-by-PTP basis. Thus, unitholders cannot use the passive losses allocated to them from one PTP to offset gains arising from the ownership of a different PTP or any other passive activities.

Following the aforementioned guidelines will provide the investor with a roadmap to making decisions and planning for the tax consequences of their ownership interest in a PTP."

Please remember to rate my response.

Thanks very much,

Steve G.

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Customer reply replied 4 months ago
I understand all that. But you didn't answer my question. I thought I was putting the question to someone from TurboTax. The TurboTax interview for entering K-! information does not ask whether all, or only a portion, of an MLP position was sold. As a result in the instances I cited in my question, partial MLP positions were sold but TurboTax treated the sale as a complete sale. That's the way the return was filed in the three instances I cited. The full suspended loss carry forwards wiped out any ordinary gain resulting form the sales, resulting in no tax from the transaction My question is whether TurboTax stands behind the results in case of an audit. Apparently you can't answer that question for TurboTax.
Tax Professional: Stephen G., Sr Income Tax Expert replied 4 months ago

You asked "Whose right?" referring to whether the TurboTax Program or the CPAs were correct. That's the question I responded to.

However, there is a known problem in this area for the Turbo-Tax program. See the following link & scroll down to #1 relating to partial dispositions.

https://ttlc.intuit.com/questions/3760966-how-i-report-the-sale-of-mlp-shares-in-turbo-tax-i-sold-all-shares

As far as the TurboTax software protecting you from an audit finding of "unreported ordinary gain", it won't protect you from the IRS, including penalties and interest. It would be up to you to attempt to recover from Turbo-Tax but the most you can probably count on would be reimbursement of penalties & interest. Turbo-tax is not going to fight the battle with the IRS in terms of their program issues, particularly since it appears that their program is in error.

I would think you would have a good case against Turbo-tax, but I presume that you would have to take them to Court to try and collect more than penalties and interest as their position would be that in the end you owe the tax anyway, despite the error in their program. Turbo-tax claims to stand behind their computations, but the question is whether or not the program is designed to handle this particular issue in the first place.

I'm just trying to give you a practical answer and perhaps it would be smart to raise the issue with Turbo-tax support before it turns into a real audit issue so you can decide if you should file an amended return now, rather than later to mitigate any potential issues with the IRS.

Steve G.

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