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Why you should track your passive losses

December 30, 2008

If you have an old tax shelter that keeps sending you K-1s with losses you never get to use because they are "passive," it can be tempting to just not bother to continue to track the loss. Filing Form 8582 with all of its worksheets is a hassle, after all. But the hassle can be worth it, as the former CEO of Gulfstream Aerospace learned yesterday in Tax Court.

William Lowe invested in a limited partnership in 1985. He moved around a lot, and he didn't bother to report the K-1 information or carryforwards for 1985-1990, or for 1992. He did include K-1 information from 1994 through 2002.

As often happens, the tax shelter wound up in 2003 with a big gain. At that point Mr. Lowe decided that the K-1 losses were worth something after all. He apparently got copies of the old K-1s and deducted the amounts as carryforward losses against his income.

The Tax Court noted a few problems with his computations:

- He had already deducted losses for 1991 and 1993 as non-passive.
- He had no copies of his pre-1991 returns to show that he had not claimed the losses before then.
-His 1991 return apparently had no Form 8582 tracking a passive loss carryforward from the earlier years.

The Tax Court allowed the passive loss carryforwards from the years that he had tracked - the post-1993 losses. As for the others:

Petitioners' argument that the pre-'93 losses subject to section 469, in whole or in part (1987-92), were not deducted is not based upon the returns for those years (which are not in evidence) or even upon Mr. Lowe's recollection based upon his prior review of those returns but, instead, upon his "belief" that those losses "were never claimed". That belief, based upon an alleged conversation that took place some 22 years earlier, is belied by the 1991 return, which shows that the firm responsible for preparing the 1985-92 returns treated the loss reflected on the 1991 Schedule K-1 as a deductible, ordinary loss.

The court notes that the passive loss rules didn't even take effect until 1987, and that the disallowance was phased in after that, so it would be surprising if at least some of the losses had not been taken.

The Moral? Track your losses; they could come in handy someday. Also, while you don't need to keep all of your old tax records, old tax returns can come in handy in measuring basis and loss carryforwards; if you have room, keep them.

Cite: Lowe, T.C. Memo 2008-298

Tags: passive losses.tax court.