2017 Essential Tax and Wealth Planning Guide

Ω Tax implications of fund investing Investment fund attributes 2017 Essential Tax and Wealth Planning Guide | Tax implications of fund investing Introduction What is an investment fund? Types of investment funds and income tax characteristics • Marketable securities Hedge funds • Private equity/venture capital Publicly traded partnerships Real estate funds . Fund of funds Investment fund attributes • Trader versus investor . . entities Passive versus non-passive income Separately stated activity (including PTPs) Qualified small business stock (QSBS) Unrelated business taxable income • State tax reporting Conclusion Resources Trader versus investor status Typically, funds like MSFS and HFS will either be determined to be a trader (in the business of trading securities) or an investor (not in the trade or business of trading securities). This annual determination is based on the facts and circumstances of the fund surrounding frequency of trading, holding period, etc. There is no statutory definition of a trader vs. an investor, and the fund must complete an annual analysis to determine whether it is a trader or an investor for the current year. Typically, a trader is a taxpayer who buys and sells securities with reasonable frequency in an effort to catch swings in the market and profit thereby on a short-term basis. A trader can be engaged in a trade or business if the activity is conducted with continuity and regularity and with a primary purpose of producing economic income or profit. A fund that is classified as an investor typically has less trading activity and seeks to profit from more long-term investments. If the fund qualifies as a trader, then its activities will be considered in the connection of a trade or business. Expenses such as management fees or fund expenses will be classified as trade or business expenses, fully available to offset an investor's ordinary income from the trader, as well as other sources. Conversely, if the fund is considered to be an investor, any management fees or fund expenses will not be considered in connection with a trade or business and may be limited by the itemized deduction phase-out provisions or added back under the AMT regime. Typically, most private equity/real estate investment funds are invested in other operating business, such that the fund itself is determined not to be in the trade or business of purchasing other private equity or real estate investment funds. Consequently, most management fees or fund expenses incurred are not in connection with a traditional trade or business and may be subject to the itemized deduction phase-out provisions or added back under the AMT regime, unless the operating businesses are pass throughs and it is determined that the expenses are deductible like other expenses incurred directly in the operating businesses. $ Passive activity versus non-passive activity Ordinary income or loss generated from fund investments is typically either passive or non-passive. Passive income and losses are often generated by a rental activity or an operating business in which the taxpayer does not materially participate. Items that are non-passive income include portfolio income such as interest, dividends, and gains on stocks and bonds. Investment activity from marketable security and hedge funds is almost always not considered passive income, either because it is portfolio income or because it is trading income. Passive losses are only deductible by an investor to the extent of an investor's overall passive income. If, in a given year, an investor has more passive losses than passive income, the excess passive losses can be carried forward indefinitely to future years. To the extent a taxpayer has carryforward losses from an investment and the investment is completely disposed of in a fully taxable transaction to an unrelated party, such losses are deductible in the year of the disposition regardless of whether the taxpayer has other passive income to offset the losses. The deductibility of carryover losses in the year of complete disposition is dependent upon how the investor has grouped its passive activities. 今 <弓 ☑ |||| A 57

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