Can you inherit suspended losses?

[Corduroy Frog]

George and Elizabeth owned rental property, and consistently have AGIs well over $150,000.  As a result, they have accumulated losses of over $75000 that they have not been able to deduct.  They both die in the same year (maybe a car wreck), and their son Robert will inherit the rental house, FMV of $300,000.

Robert's FMV stepped up is $300,000.  Can he inherit the $75,000 in his parent's impounded losses?

In other words, can he:

1. Sell the house with basis of $375,000, or is his basis only $300,000?
2. Continue to rent the house and absorb the $75,000 as his own impounded losses going forward?

 

[jklcpa]

No, not the heir, but if you are preparing the final tax return for George & Elizabeth, they may be able to finally use some of the suspended losses.  The property is considered disposed of on their final personal income tax return.  Below is the paragraph that explains how it would work, and that is taken from this article by The Tax Advisor: https://www.thetaxadviser.com/issues/2017/jan/carryovers-death-spouse/
 

Quote

Passive activity loss carryovers: Suspended passive activity losses (PALs) must be traced to the owner of the activity. Under Sec. 469(g)(2)(b), any of the decedent’s PAL carryovers are allowed on the final joint return for the year of death, as the activity is considered disposed of. However, the amount of carryover that can be deducted must be reduced by the excess of the basis of the property in the hands of the transferee (the heir) over the decedent’s adjusted basis in the property just before death. In other words, the amount of loss equal to the step-up in basis at death is not allowed to the decedent or to anyone else because the heirs receive that tax benefit from the step-up in basis. If the decedent’s PAL carryover is less than the step-up in basis, none of the carryover is allowed on the final return.

 

 

[Corduroy Frog]

Excellent response Judy and thank you.   From your response,

1. The heirs are not entitled to the impounded loss, although do acquire the rental house at stepped up basis.
2. The deceased can treat the house as disposed, which should free the impounded loss.  I didn't know this - for example if there is a Capital Loss carryforward by virtue of the $3000 limit, the capital loss carryforward dies with them. 

 

[Margaret CPA in OH]

Good question here which brings to mind the issue with my client having a condo in a revocable trust.  As it has been determined that the losses for 2024 cannot be taken (short term rental, etc.), when the client dies (within months) and the trust becomes irrevocable, what happens to the losses?  Since it is in trust, is that the same as being considered disposed of?  I wouldn't think so.

I think the surviving daughters will likely be named as the heirs to the condo but do the losses go with it?  I doubt I will be preparing the final return for this client as the daughters will take over but thought I might be prepared, just in case.

[Corduroy Frog]

Please correct me if I'm wrong, but I believe for purposes of the IRS, a recovable trust is ignored (as if it had never occurred).  If the trust is created by state statutes, it probably exists for state law unless it piggy-backs with the IRS.

By contrast. an irrevocable trust has it's own identity, and must file a 1041 with the IRS for every year it exists.  The basis of its assets are frozen as their value as of the date of its creation.

[Margaret CPA in OH]

No question about your statements, Corduroy Frog.  My question is in regard to the losses when that trust becomes irrevocable.  I did not ask about the basis only the losses.  Or are the losses taken when the trust becomes irrevocable?