Another puzzling REG question from CPAReviewForFree.com:

Donald is in possession of a K-1 from a limited partnership in which he was a limited partner. The limited partnership interest was traded on a national stock exchange and registered with the SEC under the 1934 Act. If the K-1 received by Donald reflects a loss, which of the following is correct?

A. Donald cannot recognize this loss on his current year Individual Income Tax Return
B. Donald can recognize this loss on his current year Individual Income Tax Return
C. Donald can recognize $3,000 of the loss reported on the K-1 and carry the rest of the loss forward indefinitely
D. None of these options is correct

I'm totally lost on this: Wiley says B is correct!! I thought Passive Activity Losses are not recognizable against ordinary income?

I'm stumped but I'll attempt to answer this question anyways.

I wonder if this question is a matter of semantics. Just because you "can" deduct the LP passive loss doesn't mean that you "will" in the current tax return. As you know, passive income can only be offset by passive losses. Perhaps they meant that there may or may not be passive income to offset passive losses. Or that the passive losses can be carryforwarded.

Here is what I read from my textbook:

LOSS LIMITATIONS

Partnership losses flow thru to the partner for use on their income tax returns. However, the amount and nature of the losses allowed in a partner's tax computations may be limited. When limitations apply, all or a portion of the losses are held in suspension until a triggering event occurs. Only then can the losses be used to determine the partner's tax liability. No time limit is imposed on such carryforwards of losses.

Three different limitations may apply to partnership losses that are passed thru to a partner:

*The first is the overall limitation contained in Sec 704(d). This limitation allows the deduction of losses only to the extent the partner has adjusted basis for the partnership interest.

*Losses that are deductible under the overall limitations may then be subject to the ar-risk limitation of Sec 465. Losses are deductible under this provision only to the extent the partner is at risk for the partnership interest.

*Any losses that survive this second limitation may be subject to a third limitation, the passive loss rules of Sec 469.

Only losses that make it thru all these applicable limitations are eligible to be deducted on the partner's return.

I don't know the relevance of the LP being a publicly traded stock?

Anyways, I hope this helps.