Passive activity loss, final k-1 merged with new PTP

Not my area of expertise. Answer is based on one graduate class on this subject and my understanding of Section 708(b)(2) and the final regulations published in 2002.

The general rule is that after two partnerships merge for tax purposes, one of the original partnerships is considered to have terminated.

Here is the relevant part from the regulation as to whether you can consider your merged partnership terminated. If it is considered terminated, then your suspended loses can be recognized.

c) Merger or c A merging partnership will be considered terminated after the merger if the members of that merging partnership wind up with less than 50 percent of the capital and profits of the new partnership. However, if the members of two or more merging partnerships wind up owning more than 50 percent of the capital and profits of the new partnership, the partnership that is credited with contributing assets with the smallest fair market value (net of liabilities) will be considered terminated. Lastly, if the members of the new partnership who own more than 50% were not members of any of the merged partnerships, then all of the merged partnerships are considered terminated and you have yourself a brand new partnership.

The regulations go on to explain how you are supposed to make the determination as to who contributed the greater amount of assets.

No. Your accumulated losses are still suspended.

In deference to the other reply that went into partnership status, the basic rule of passive activities is that the loss is suspended until FULL disposition of the ACTIVITY. You didn't dispose of the activity. You simply changed the entity you participate in it through. Both before and after, you have the same set of activities; the only difference is that you have one less entity. Therefore, you haven't disposed of it.

I agree that one entity has terminated. However, the underlying passive activity hasn't.

Okay, you forced me to research this. For sake of this discussion, let's assume that Sec. 704(d) does not limit loss recognition. I.e., the partner has a basis in the partnership.

TRA '86 (PL 99-514) formed the basis for the passive activity rules. Rather than try to make sense of all the Regs I took a look at the committee reports as they are much easier to read and interpret.

I agree with you that termination of the partnership will not by itself free up passive losses. An entity is not an activity. Here's a quote from the Senate report:

"The taxpayer must dispose of his entire interest in an activity in order to trigger the recognition of loss. If he disposes of less than his entire interest, then the issue of ultimate economic gain or loss on his investment in the activity remains unresolved. A disposition of the taxpayer?s entire interest involves a disposition of the taxpayer's interest in all entities that are engaged in the activity, and ... all assets used or created in the activity."

Therefore, I must conclude that the suspended losses would only be allowed if 1. losses are not limited by basis and 2. the activity that triggered the passive losses or the assets that triggered the losses are disposed of.

I agree with your second analysis. I had one of those PTP mergers myself. I think the original poster is correct that at the beginning of 2010 you add the suspended losses of the terminated PTP to the suspended losses of the continuing PTP and continue until you liquidate all of your investment in the second PTP.

Sometimes an MLP will convert to a corporation. You get stock and a final K-1. I think here it is treated as if you fully disposed of the partnership even though you have the stock. This is not the case that the OP described.

That's still a change in entity without disposition of the activity, and therefore, no suspended PAL.

Interesting. So would you expect a K-1 if you sold that C-corp stock in a later year?

No, I think you would have to remember it on your own. The IRS would be happy if you forgot about your suspended losses.

No. Tracking of suspended passive activity losses is each taxpayer's problem.