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From CCH:

When a taxpayer exchanges an interest in a passive activity in a nonrecognition transaction suspended passive activity losses do not become deductible except to the extent that the taxpayer recognizes gain in the transaction. The gain is treated as passive income. Nonrecognition transactions include the following:

  • a transfer to a corporation controlled by the transferor;

  • contributions of property to a partnership in exchange for an interest in the partnership; and


My client firm was a partnership until 12/31/2021.  I took over the 1040 for one of the partners and I see a loss on E in 2021 entitled "Company Name - Former Passive". I don't know the source of this loss as I have not asked his previous CPA about it.  I had assumed this partner has always been an active owner. It was a consulting partnership, and he was the founder of the firm years back.

As of 1/1/22 the partnership converted to an S Corporation. This was tax free; there was no gain.  

Conclusion:  Because there was no taxable event on the conversion, the PAL is not allowed to be deducted in 2022.

Your opinion is greatly appreciated.

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1 Comment 1
Level 15

I agree.