10.7 Tax Credits of Passive Activities Limited

You may generally not claim a tax credit from a passive activity unless you report and pay taxes on income from a passive activity. Furthermore, the tax allocated to that income must be at least as much as the credit. If the tax credit exceeds your tax liability on income allocable to passive activities, the excess credit is not allowed. Use Form 8582-CR to figure the allowable credit. Suspended credits are not allowed when property is disposed of. The credits may be used only when passive income is earned.

EXAMPLE
Ben Wall has a $1,000 credit from a passive activity. He does not report income from any passive activity. He may not claim the credit because no part of his tax is attributed to passive activity income. The credit is suspended until he has income from a passive activity and he incurs tax on that income. All or part of the credit may then be claimed to offset the tax. If he disposed of his interest before using a suspended credit, the credit may no longer be claimed but the election to reduce basis, discussed below, could be made.

Credits for real estate activities.

More favorable tax credit rules apply to real estate activities (10.2).

Basis adjustment for suspended credits.

If the basis of property was reduced by tax credits, you may elect on Form 8582-CR to add back a suspended credit to the basis when your entire interest in an activity is disposed of. If the property is disposed of in a transaction that is not treated as a fully taxable disposition (10.13), then no basis adjustment is allowed.

EXAMPLE
Mark places in service rehabilitation credit property and claims an allowable credit of $50, which also reduces basis by $50. However, under the passive loss rule, he is prevented from claiming the credit. In a later year, he disposes of his entire interest in the activity, including the property whose basis was reduced. He may elect to increase basis of the property by the amount of the original basis adjustment.
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