IRC 469 Page 3 1
IRC 469(h) & Reg. 1.469-5T(a)
Concerns
•Does TP materially participate in an out-of-state Sch C or F? •Does TP materially participate in out-of-state 1065 or 1120S business? •Does TP materially participate in a short-term rental? ... .. .. .. .. .
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MATERIAL PARTICIPATION IRC §469(h) & Reg. §1.469-5T CALENDAR nday
Regular
Monday
Tuesday
Wednesday
Thursday
Friday
Saturday
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CALENDAR nday
Monday
Tuesday
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Thursday
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Continuous
Saturday 2
CALENDAR 4
5 nday
6 Monday
7 Tuesday
8 Wednesday
9 Thursday
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Saturday
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8 Tuesday
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9 Wednesday
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CALENDAR
16 7 Monday
nday
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and
Friday 1
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Friday
Saturday
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Substantial Participation in operations The devil (and IRS) is in the details!3 Page 3
MANAGERIAL AUTHORITY DOES NOT EQUATE TO MATERIAL PARTICIPATION! TP materially participates only if he meets one of the following hourly tests: • • • • • •
500 hours Does most of work 100 hrs and no one does more 100-500 hours in passive businesses Material participant any 5 of last 10 yrs Material participant in personal service activity any 3 prior yrs • Facts and circumstances but N/A if anyone paid to manage activity
MATERIAL PARTICIPATION does not apply to . . .
Except:
Rentals are passive even if TP materially participates!
•Rentals of a real estate professional
FOR RENT!
•Activity is excepted from rental definition. Ex: average customer use is 7 days or less Hotel, vacation condo, B&B
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Reg. 1.469-5T(f)(4)
Records ... Appointment Books, Calendars, or Narrative summaries
which show: An identification of services done over a period of time, and Approximate number of hours spent in those services. Suggestion: Calendar with service & hrs 6
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Reg. 1.469-5T(f)(2)(B)
Investor-type time is disregarded … unless TP is directly involved in daily operations or management.
*Studying or reviewing financial statements & reports. *Preparing summaries or analyses for TP’s own use. *Monitoring finances or operations in a non-managerial capacity (telcals, visits).
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IRC 469(h)
Time Counted? Log on Page 31 •3 hours a day thinking & strategizing •Does a weekly drive-by •1 hr daily discussion with on-site manager •63 hrs researching new equipment to buy •24 hrs installing new wiring •6 hrs to unplug the toilet •8 hrs on horseback checking the fields •4 weekend visits to condo to wash windows •Visited farm weekends, checked operations ??? 8
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IRC 469(h)
Hours Counted? •5 hrs a week reading journals & newspaper •8 hrs property manager’s funeral •35 hrs preparing Sch. E •40 hrs setting up corp •28 hrs investigating new property to buy •30 minutes daily reviewing reports •52 shop trips for 5 rentals – 2 hours each •2 hrs a weeks going to bank and post office •15 hrs a month writing checks & bookkeeping •8 hrs monitoring the repairman ??? 9
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IRS AUDIT MATERIAL PARTICIPATION
NO SUBSTITUTE FOR SERVICES & HOURS…
BUT could be helpful: • Affidavits from foreman, employees, etc. • Third party statement: banker, attorney Also consider – • History – material participation 5 of 10 years • Possibly passive income from another entity • Disposition in next year or two 10
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LLC Member = Limited Partner!? No! A partnership interest is a limited partnership interest IF the holder’s liability is limited by State Law. Reg. 1.469-5T(e)(3)(i)(B) s
Virtually all LLC members have limited liability under State law. BUT Garnett v Comm 32 T.C. 19 TP holds both GP & LP interest Reg 1.469-5T(e)(3)(ii) Result: Managing Member can use any of 7 tests11
BOTTOM LINE PROBLEMS
DECISION •IRS will With conformCOURT’S to Garnett LLC issue. •If TP is member-manager, he has any of 7 tests to prove material participation in a business. •Determine member-manager from K-1 item G. •If not a member-manager, only 3 tests for material ptn: •500 hours •Material participation in 5 of last 10 years •Materially participated in personal service activity any 3 prior years
•Rentals are passive even if TP materially participated! 12
IRC 469(h)(4)
C Corporations
One or more shareholders, who own more than 50% of the corporate stock, must materially participate.
Estates & Trusts The trustee / executor / fiduciary must materially participate. No Regs! Notice that it is not the beneficiary. Beneficiary’s time is not relevant. 13
Reg. 1.469-1T(e)(5) IRC 469(c)(3) IRC 469(g)
SOLD !!!
*K-1 losses from 1065 trader in stocks & bonds
*Working interests in oil & gas Working interest = liability not limited
*All current & carryover losses are allowed if sold to unrelated party in fully taxable transaction. 14
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• • • •
Husband & wife get K-1s with losses from same partnership. Only husband works in 1065 business. Wife does nothing. Can she claim losses?
Yes! Activities of one are attributed to other. Careful inputting K-1s. Mark YES for material participation for both spouses. Page 3
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IRS questions material participation in an 1120S. Gives TP log to complete. TP is very busy & unsure of work done. Must he complete the log? • • • •
Technically no, but … Log meets recordkeeping rules. Services performed And hours for those services. 16
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How do I “IRS-proof” my client’s time log? Look for hours which don’t count! • Time before TP owned activity. • Reading, budgets, telcals, 1040, investor-type time unless involved daily. • Work not customary. • Travel. • Work done in another tax year. • Work done by someone else. • Inflated time. 17
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Narrative summary for material participation? Why isn’t that easier?
• Reg. 1.469-5T(f)(4) still requires services & hours attributable to those services. • Vague, ambiguous generalities not acceptable! • Lots of cases lost by taxpayers. 18
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Client is a limited partner in several partnerships. K-1s LP. Possibility he’s non-passive in any? Sure! • Trader in stocks & bonds always non-passive, even limited partner. • TP is both GP and LP: all 7 tests. • Worked more than 500 hours. • LP grouped with business where TP works. • Non-passive on disposition. • Right to manage at all times: 7 tests. Proposed Reg. 1.469-5T(e)(3) 19
QUESTIONS ???
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