COMMON MISTAKES With PASSIVE ACTIVITIES
§ 469 - Form 8582
Page 5-9
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Treat ALL 1065 & 1120S nonpassive
7+ entities nonpassive could raise IRS Agent’s eyebrows!
Law: TP must materially participate in each activity.
Reasonable explanations -Relateds grouped as one single activity Best! -Several significant participation activities (SPA) Businesses: 100-500 each Total SPA hours are more than 500.
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Treat equipment leasing nonpassive Sch. C or K-1 line 3
Law: Rentals are passive
even if TP materially participated.
Reasonable explanations -Grouped with business if same % or insubstantial. Disclose new grouping beginning in 2011. -Entire disposition to unrelated party – Disclose!
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Deduct rental real estate losses when AGI is more than $150,000! Law: $25,000 offset phased out when modified AGI is more than $150,000.
Reasonable explanations
-Entire disposition to unrelated party. Disclose! -RE Pro who materially participated in each rental. -Rental was grouped with a business.
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Real estate professional And 10+ rentals all nonpassive Law: Material participation required in each rental Reasonable explanations -Grouped all rentals as one activity (election in prior yr) and worked more than 500 hours on rentals. -Entire disposition to unrelated party.
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Sch. E net income on Form 8582 when property leased to TP’s corp or p-ship
Law: Self-rented property income is not passive Reasonable explanations None!
Au contraire, mon frere. No way, Jose. Not on F8582. Not allowed to offset other passive losses.
BIGGEST MISTAKE OF ALL!
Forgetting … about the passive loss rules.
Page 5
PASSIVE LOSS LIMITATIONS APPLY TO:
All rentals, even if TP materially participated! K-1 lines 2 and 3 Possible Exception: RE Pro Businesses if TP does not materially participate Page 2
PASSIVE LOSS RULES IMPACT
Sch. CSch. E Sch. F Partnership K-1s S corporation K-1s Trusts: complex/simple/grantor Estates Personal service corporations Some closely held C corporations Net investment income Page 2
INADVERTENT TROUBLE!
Sch. C equipment leased To TP’s corporation Sch. E building leased To TP’s corporation Business and leasing activity In same location
Reg. 1.469-5T(a)
MANAGERIAL AUTHORITY DOES NOT EQUATE TO MATERIAL PARTICIPATION! TP materially participates only if:
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 Page 3
RECORDS TO PROVE PARTICIPATION Flawed thinking:
Oral testimony is enough Affidavits will work Narrative is okay Easiest: Calendar!
Law: Services and Hours Contemporaneous records IFReasonable means not provided Page 3
HOURS NOT COUNTED!
Prior year time Time before TP had ownership Investor-type time: Reading, reviewing stmts, monitoring Work not customarily done by an owner Travel time Inflated time Page 3
TAX SOFTWARE CONSIDERATIONS
K-1 Line 1 trading partnership is always nonpassive even if TP is Limited Partner!
Income from self-rented property does not go on Form 8582!
Income from land does not go on 8582.
Royalty income does not go on 8582.
IRC 1031 (likekind exch) doesn’t release losses.
Publicly traded partnerships Page 6
MISTAKE: NOT CONSIDERING GROUPING BUSINESSES
Reg. 1.469-4 allows related businesses to be grouped as one activity, based on
Similarities, ownership, control, location, interdependencies
When entity first appears on Form 1040
Disclose & document any grouping!
No return disclosure till 2011 (Rev Proc 2010-13) but document any grouping (tax workpapers/1040)! Page 7
MISTAKE: GROUPING RENTAL with A BUSINESS Reg. 1.469-4(d) prohibits grouping a rental activity and a business unless …
Insubstantial (no definition) Owned in identical percentages and property is leased to the business
Rental can never be grouped with C corp! Page 7
RENTALS – GENERAL RULES TP gets up to $25,000 rental loss if:
Modified AGI is under $100,000 Phaseout between $100-150,000 Must meet “active participation” Material participation is not relevant NOT available to short-term rentals
MISTAKE: NOT CONSIDERING GROUPING RENTALS OF RE PRO Flawed thinking … If TP is a real estate professional, his rentals are all nonpassive!
Au contraire! RE Pro’s rental is passive unless TP materially participates in the rental! Page 8 & 12
ELECTION TO GROUP RENTALS
Statement with original return: TP is RE Pro and elects to group all rentals as one activity Made by individual investor Can be made in any year Governs that year and all future years Not required, but OK to disclose every yr Rentals still go on Sch. E (not Sch. C) Entry on Sch. E line 43 is not an election! Page 12
CONSIDER … IS ACTIVITY A RENTAL OR IS IT A BUSINESS? Not a rental activity:
Average use is 7 days or less Used 30 days or less & services Extraordinary personal services provided
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Vacation Property Considerations
Average use of 7 days or less Not included in RE Pro computations Not part of RE Pro grouping of rentals If TP does not materially participate, losses go on Form 8582 Line 3 (not Line 1) May have IRC 280A psl use limitations
CONSIDER … IRC 280A Personal use of a “living facility” Allocation of expenses required between business and personal use. IF personal use more than14 days or 10%, then …
Business expenses are limited to income Carry over excess business expenses to future years against operating income If no income, expenses are lost Limitation applies to 1040, 1065 & 1120S
HELP!
This stuff can be complex!
Code § 469 & regulations No regs on dispositions nor trusts IRS Publication 925 Passive Activity Loss Ref. Guide at www.IRS.gov
Questions?
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QUESTIONS???
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The Typical Auditor
by Elbert Hubbard From the Internal Auditor, April 1989
The typical auditor is past middle age, spare, wrinkled, intelligent, cold, passive, non-committal, with eyes like a codfish, polite in contact, but at the same time unresponsive, calm, and damnably composed as a concrete post. A human petrification with a heart of feldspar, without charm, no friendliness, minus any passion and certainly no sense of humor. Happily, he never reproduces and all of them finally go to hell!
