YOUR TAXES: A SPECIAL REPORT : TAX SHELTERS : Strict Rules Govern Those That Have Survived

Times Staff Writer

In its quest for greater fairness, the Tax Reform Act of 1986 eliminated many of the rules that had made real estate and other tax shelters a cherished part of the investment strategy of many Americans.

The impact of the 1986 changes will be felt with greater force this year. It will be compounded by other changes, added by Congress in the final days of its 1987 session, that robbed the shelters of some of their remaining attraction.

And, as if that bad news weren’t enough, this year the rules governing use of such shelters have been made longer and more complicated.


“These days, people need to take a hard look at whether these kinds of investments are really of benefit to them at all,” said Robert Heier, an investment adviser in Reston, Va. “Now it’s a question of weighing their value entirely on the income they can produce, compared to other investments.”

The advantage of the shelters lay, of course, in their ability to generate tax losses that an investor could use to reduce his taxable income from salary, interest, dividends or other sources. In the early 1980s, in particular, investors flocked to real estate partnerships, oil and gas shelters and similar deals that, in some cases, offered deductions totaling three or more times what the individual invested.

The shelters produced tax losses to the extent that their deductible business expenses exceeded their income. (A particular advantage of these deals was that some of their expenses were non-cash, bookkeeping charges such as depreciation; they were not out-of-pocket expenses for the investor.)

But the shelter business’s palmy days ended abruptly in 1986, when Congress sharply limited the extent to which the losses could be used to offset income. The new law said tax shelter losses, or “passive” activity losses, could be deducted only against income from other passive activities--not against ordinary income from wages and salaries or “portfolio” income from interest and dividends.

Congress gave some limited protection to investors who had money in shelters before Oct. 23, 1986. The new law said these investors could still deduct against ordinary income a declining portion of their tax losses, from a 65% share this year to zero in 1991. And whatever losses were not used in the current year could be carried forward to later years or used to reduce the investor’s capital gain when he sells his stake in the partnership.

The effect of these new rules was to set off a stampede to income-oriented partnerships by investors who expected that earnings from these deals would be fully offset by losses from their early shelter investments.


But taxpayers who fled to the investments called master limited partnerships were in for yet another disappointment. At the end of 1987, Congress ruled that tax shelter losses could not be used to offset income produced by master limited partnerships.

These latest changes ruled that income from master limited partnerships would no longer be classified as passive but instead as “portfolio” income--the same category as investments in stocks and bonds. This rule was made effective for 1987 tax returns.

Investors in master limited partnerships are actually buying a security that represents a stake in a collection of assets, and the security is traded on stock exchanges. Shares in these partnerships have also been attractive because the income they generate is not subject to corporate but only to personal income taxes.

Since the 1987 changes did not exclude the sheltering of income from private real estate partnerships, however, big brokerages and real estate promoters have recently been busy setting up partnerships that generated income that could be sheltered by losses from earlier investments. In many cases, the promoters restructured partnerships that had been generating tax losses so that they now produced regular income distributions.

Such private partnerships usually promise returns of 4% to 12% annually.

The tax code still allows old-style writeoffs for losses from two kinds of real estate investments--rehabilitation and low-income housing projects. Losses on such projects can generate tax credits that can offset up to $25,000 of salary and other income.

Taxpayers with adjusted gross incomes of more than $200,000 are not entitled to receive the full credit, however. The tax code scales back the benefits for taxpayers with adjusted gross incomes of more than $200,000, reducing the benefit to zero when the taxpayer’s adjusted gross income reaches $250,000.


Taxpayers struggling to understand the ramifications of these tax-law changes also face the burden of added paper work. The Internal Revenue Service this year requires taxpayers with shelter losses to fill out Form 8582, which is six pages long and bristles with new and complicated terminology.

Some tax advisers predict, too, that many shelter managers will be slower in distributing the information that taxpayers will need this year, since many do not yet fully understand what the new law entails. Indeed, the IRS still must clarify some of the rules regarding use of shelters.

The effect of the tax law changes is dramatically evident in the statistics on investment in the partnerships. Investments in private real estate partnerships had trailed off to $1.5 billion last year from a robust $10.5 billion in 1984, according to Robert A. Stanger & Co., a New Jersey research firm.

Real estate master limited partnerships had declined to $473 million last year from $972 million in 1986, Stanger reported.