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Should You Put A PIG In Your Pen?

It's okay to be a "pig" when you're talking about investment strategies designed to reduce income tax liability. But that doesn't mean you should be overly greedy.

In this case, we're referring to "passive income generators" or PIGs for short.

Depending on your situation, you might invest in a PIG, especially as the year draws to a close, as a way to offset losses incurred through other passive activities. The income from the PIG can absorb prior losses and is essentially tax-free up to the amount of the total loss.

Here are the details: The passive activity laws, which were enacted in 1986, were designed to prevent upper-income investors from using losses from tax shelter deals--such as oil and gas drilling and cattle breeding--to claim large losses in the early years of ownership. Before those laws were passed, such deals often helped wealthy taxpayers cut their tax bills to next to nothing.

Under the revised tax rules, you now can use only losses from passive activities incurred during the year to offset income from passive activities that you received during the same year. Any excess loss from your passive activities can't offset other, highly taxed non-passive income, such as your salary or regular business income. Excess passive activity losses (PALs) are suspended indefinitely until a year in which you have passive income.

What kinds of activities are considered to be passive activities? Generally, the definition covers any kind of trade or business in which you do not "materially participate." For example, if you invest in an oil and gas or cattle breeding deal in a limited partnership, it is treated as a passive activity. Rental real estate is treated automatically as a passive activity although special tax law provisions may provide partial benefits in some cases and full benefits to real estate professionals. Another exception applies to a "working interest" in oil and gas (for example, if you actually work out in the field).

It didn't take long after Congress clamped down, however, for clever syndicators to put a reverse spin on the classic tax shelter deal. Instead of a partnership that provides tax losses, a PIG, as the name suggests, is intended to start churning out income right away. If you invest in a PIG, you can realize current income that soaks up suspended PALs.

If your circumstances warrant it, you might consider investing in PIGs. Marketed by brokers or other sponsors, they run the gamut from ski resorts to conference centers and golf courses. But don't enter into such a deal purely for tax reasons. The offering should make sense when you consider all of the relevant economic factors. We can help you locate a PIG that meets your specific needs.