Passive Activity Losses and At-Risk

ESSAY WITH COMPUTATIONS. J.P., a wealthy investment banker, purchased an office building and underlying land (the property) for $500,000, borrowing the entire purchase price from the Last Texas Savings and Loan in two $250,000 mortgages. Both mortgages are nonrecourse and secured only by the property itself. One of the mortgages qualifies as “qualified nonrecourse financing.”

Beyond taking out the loans to purchase the property, J.P. did not invest any of his own money and did not devote any of his time to managing the office building (he hired a management company).
In the first year of operations, the results for J.P. are as follows:
Rental Income: $200,000
Interest Expense: $50,000
Operating Expense: $486,000
Depreciation Expense: $50,000
Net Loss ($386,000)
In addition to the interest paid during the year, J.P. made a $20,000 principal payment on each note (total of $40,000 principal paid). J.P. has $800,000 of salary income from his investment banking job and $80,000 of dividend income from the portfolio investments. J.P.’s depreciation was not accelerated or otherwise subject to any recapture rules.
a)	List the primary authorities relied upon in answering parts b-d below:
b) To what extent may J.P. deduct his net loss from the office building? Provide explanations as to each type of loss limitation (and whether or not they apply). List the codes and regulations that apply to your explanations.
c) In Year 2, the property generated $10,000 of net income. J.P. also earned $300,000 of salary income during the year. No principal was paid during the year. Depreciation for the year (included in the net income amount) was $14,000. Analyze the tax treatment of the property income to J.P. Cite the Codes and regulations in your answer
d) At the beginning of Year 3, when the property was worth $460,000 - exactly equal to the amount of outstanding mortgages – J.P. sold the property. The buyer took the property subject to the mortgages and paid no other consideration. What are the tax consequences of this sale to J.P.? List code sections and regulations in your answer