Definition of “activity,” rental real estate with active participation, real estate professionals, interaction with other rules 1
Definition of “activity” relevant for: Classifying activity – rental or T or B (or something else) Did taxpayer materially participate?
Did taxpayer dispose of the activity?
Blue Book TRA/86 page 245 3
Look at what is a separate activity per a “realistic economic sense” “What undertakings consist of an integrated and inter-related economic unit, conducted in coordination with or reliance upon each other, and constituting an appropriate unit for the measurement of gain or loss” Analogy to hobby loss rules of §183 is appropriate.
“The fact that two undertakings are conducted by the same entity (such as a partnership or S corporation) does not establish that they are part of the same activity. Conversely, the fact that two undertakings are conducted by different entities does not establish that they are different activities. Rather, the activity rules generally are applied by disregarding the scope of passthroughentities such as partnership and S corporations.” (pg. 247) 4
TD 8175 regs (1988) – did not define “activity” TD 8253 (1989) – included -4 on “activity” “4T(f)(4)(i) of the regulations provides that two trade or business undertakings are similar for purposes of section 1.469-4T(f) if and only if (A) there are predominant operations in each such undertaking, and (B) the predominant operations of both undertakings are in the same line of business. For purposes of this rule, there are predominant operations in an undertaking if more than 50 percent of the undertaking's gross income is attributable to operations in a single line of business.” Rev. Proc. 89-38 – listed the lines of business Replaced by TD 8565 (1994), amended by TD 8645 (1995) Generally simpler than temporary regs.
Identify “appropriate economic unit” – 1 or more business or rental activities can be treated as single activity if constitute an appropriate economic unit for the measurement of gain or loss for purposes of section 469” AEU – depends on facts and circumstances Can use “any reasonable method of applying the relevant facts and circumstances in grouping activities” 6
Similarities and differences in types of trades or businesses Extent of common control Extent of common ownership Geographical location Interdependencies between or among the activities 7
Can’t group rental with T or B Unless one is insubstantial to the other EX – owner of apartment building has a news stand outside that is open every morning Can’t group personal property rentals with real property rentals Can’t group activities of limited partners with other activities 8
T owns: Bakery and movie theater in Baltimore Bakery and movie theater in Philadelphia Question – what are possible activity groupings?
Generally must stick with original grouping If think need to regroup – see Rev. Proc. 2010-13 Be sure have documentation as to what is grouped and why.
IRS may regroup to prevent avoidance of the rules Groupings for real estate professionals See 1.469-9 (per 1.469-4(h) and RP 2010-13, §3 10
Rev. Proc. 2010-13 Follow up to Notice 2008-64.
Statement required to be filed with original return to describe: New groupings of passive activities Adding new activity to existing group Regroupings of passive activities + why P/S and S corps – follow instructions on Forms 1065 or 1120S instead.
Failure to report – treat activities as separate Relief: “timely disclosure shall be deemed made by a taxpayer who has filed all affected income tax returns consistent with the claimed grouping of activities and makes the required disclosure on the income tax return for the year in which the failure to disclose is first discovered by the taxpayer.” “If the failure to disclose is first discovered by the Service, however, the taxpayer must also have reasonable cause for not making the disclosures required by this revenue procedure.” No §9100 relief available.
IRS still has ability to regroup to prevent tax avoidance, including in situations where failure to disclose would otherwise result in separate activities ( §1.469-4(f)).
Effective for tax years beginning on or after January 25, 2010 .
In current year, AB Partnership was formed. It owns 3 apartment buildings in the Bay Area. A general partner manages all three. Partner A also owns an apartment building on his own.
Q – how many activities? Q – who does the grouping?
§469(i) Rationale – “Congress believed that a limited measure of relief, however, was appropriate in the case of certain moderate-income investors in rental real estate, who otherwise might experience cash flow difficulties with respect to investments that in may cases were designed to provide financial security, rather than to shelter a substantial amount of other income.” (Blue Book, page 214) 13
If applies, allows up to $25,000 offset for RRE with AP So could use that loss against any type of income.
Taxpayer must own at least 10% by value of the activity Active participation is lesser standard than MP Unless future regs provide an exception, a ltd partner can’t be an active participant Benefit phases out for taxpayers with MAGI between $100,000 and $150,000 Only applies to individuals and certain estates.
In measuring PAL for year, need to group RRE-AP together (-1T(f)(2)(iii)). Also see Form 8582 and instructions.
Blue Book page 244 15
Added by RRA’93 Reg. §1.469-9 Benefit? For eligible taxpayer, rental real estate (such as an apartment building) is not automatically passive RRE can’t be grouped with T or B Several cases Many involve whether taxpayer met the MP rule May not have if did not properly elect to group RRE such as to make it easier to meet MP Important to also have good records on MP 16
T owned over 30 rental properties 2001 reported aggregated loss for all properties on Sch E of about $27K Issue: Did T elect for 2001 to treat his RRE activities as single activity under §469(c)(7)?
Per court, T must show that he: (1) qualifies as real estate professional (469(c)(7)(B)) for 2001; MET – spent > 750 hours on RRE activities and it was his sole business (2) elected per 469(c)(7)(A) to treat his RRE activities as a single RRE activity at some point since 1994; and NOT met – “Since 1994 [T] aggregated his rental income and expenses as if the RRE activities were a single activity. [T] did not attach to any return a statement electing to treat his RRE activities as a single activity. The fact that [T] consistently aggregated the rental income and expenses from the rental properties on his Schedules E is not a deemed election under the requirements of section 469(c)(7)(A).” See
. TC Memo 2000-107.
(3) materially participated in combined RRE activity. Thus, T’s 2001 loss limited to $25K under §469(i).
Similarly – see
, TC Memo 2010-126
Query – how to address this issue?
H worked full time at power plant Owned 4 rental properties in NJ and Delaware H handled maintenance, tenant relations, rent collection.
Kept record of when he visited, but not of how much time spent. H prepared a summary in 2009 (apparently for auditor) 2007 – claimed Schedule E loss of $40,490. IRS disallowed $31,318, allowing deductible loss of $9,172 by applying §469(i) rental real estate with active participation rule and considering that Moss income > $100,000.
T argued he spent total of 645.5 hours + was “on call” other times to get him past the 750 hour requirement to be a “real estate professional.” IRS did not raise argument that T failed to elect to treat rentals as one activity.
Court “on call” time is not actual time spent and cannot count towards the 750+ requirement.
IRS determination upheld including assessment of accuracy related penalty.
T unable to show reasonable cause. T did not rely on his CPA because he did not provide all relevant info to CPA.
T argument that IRS mistreated them is not relevant.
Example Jane has In current tax year, has $40,000 capital gain from sale of passive activity.
Has $60,000 capital loss carryforward from prior years.
Has $70,000 PAL carryforward from prior years.
The $40,000 gain enables Jane to use: $40,000 PAL $40,000 capital loss This is NOT double dipping. This the result because of two rules at work here – capital loss limitation rule and §469.
-2T(d)(6) and -1(d)(2) Ordering of loss limitation rules: 1.
Basis §704(d) or §1366(d) 2.
At risk §465 Passive activity §469 Capital loss limitation §1211 34
Coordination with sections 613A(d) and 1211. A passive activity deduction that is not disallowed for the taxable year under 469 and the regulations may nonetheless be disallowed for taxable year under 613A(d) or 1211. The following example illustrates the application of this paragraph (d)(2):
In 1993, an individual derives $10,000 of ordinary income from passive activity X, no gains from the sale or exchange of capital assets or assets used in a trade or business, $12,000 of capital loss from passive activity Y, and no income, gain, deductions, or losses from any other passive activity. The capital loss from activity Y is a passive activity deduction (within the meaning of §1.469-2T(d)). Under section 469 and the regulations thereunder, the taxpayer is allowed $10,000 of the $12,000 passive activity deduction and has a $2,000 passive activity loss for the taxable year. Since the $10,000 passive activity deduction allowed under section 469 is a capital loss, such deduction is allowable for the taxable year only to the extent provided under section 1211. Therefore, the taxpayer is allowed $3,000 of the $10,000 capital loss under section 1211 and has a $7,000 capital loss carryover (within the meaning of section 1212(b)) to the succeeding taxable year. 35
Tom invested $50 in Partnership P that owns an apartment building.
Tom’s current year loss is $70 and is a PAL.
In subsequent year, Tom contributes $30 to the partnership. His PAL for that year is $10 + Y1 amount.
Treatment of Tom’s losses: Y1 - $50 usable under §704(d) and $20 carries forward until he has enough p/s basis.
Assuming he has at least $50 at risk amount, next get to §469 limitation. He has no PAI so the $50 becomes a suspended PAL.
Y2 – basis in p/s increases $30 so the Y1 $20 loss becomes usable and assume he also has $30 more at-risk amount. So now, is stuck at the §469 limitation. Has PAL of $100 (Y1 + Y2)* * error caught on lecture/video, should be PAL of $80 36
Recordkeeping Need to label losses as to why it is carried forward (under what loss limitation so know how to use it in future) Planning – referring back to example with Tom If is not rental activity and Tom participates in Y2, would cause the losses to be allowed (no never got to in Y2, Tom MPs in that year. §469 hurdle). Does not matter that he did not MP in Y1 since $20 of the Y1 loss §469 until Y2 when he had more p/s basis. Also, if MP in Y2, the $10 loss from Y2 is not PAL and neither is the $20 because once it gets past p/s basis limit The $50 that carried forward from Y1 as limited under when Tom MPs; per §469(f) on §469 is usable in Y2 against income from the same activity in Y2
former passive activities
§1.469-5T(b) Facts and circumstances.
(2) Certain participation insufficient to constitute material participation under this paragraph (b).
(i) Participation satisfying standards not contained in section 469. Except as provided in section 469(h)(3) and paragraph (h)(2) of this section (relating to certain retired individuals and surviving spouses in the case of farming activities), the fact that an individual satisfies the requirements of any participation standard (whether or not referred to as “material participation”) under any provision (including sections 1402* and 2032A and the regulations thereunder) other than section 469 and the regulations thereunder shall not be taken into account in determining whether such individual materially participates in any activity for any taxable year for purposes of section 469 and the regulations thereunder. * self-employment tax 38
§1.469-1T(d)(3) Suspended (currently unusable) PAL can’t reduce taxpayer’s income taxes or self-employment taxes.
§1441(c)(1) and (2) – net investment income includes: Gross income from rents Other gross income derived from a passive activity (within the meaning of §469) Gains from property dispositions other than used in a T or B Less – “the deductions allowed by this subtitle which are properly allocable to such gross income or net gain” 40
AMT 1987 – 1990 phase-in rules did not apply for AMT (so will have different PAL) Compute PAL and PAI using AMT preference and adjustment items Casualty losses per §165(h) -2(d)(2)(xi) – certain casualty and theft losses are NOT PADs Notice 90-21 – coordination of §§469, 165 and 280B 41
NOLs Blue Book pg 222 Prior year suspended PALs are used against current year PAI before NOL carryovers 42
Per Blue Book TRA’86 (pg 226) – “An installment sale of the taxpayer’s entire interest in an activity in a fully taxable transaction triggers the allowance of suspended losses. The losses are allowed in the ratio that the gain recognized in each year bears to the total gain on the sale.” Also see §469(g)(3).
Blue Book TRA’86 (pg 226) – Transfer of passive activity due to death of owner results in suspended PAL to be allowed to extent it exceeds amount by which the basis of the interest in the activity is increased at death under §1014.
Suspended PAL is eliminated to extent of basis step up. [arguably, used against that “built-in” gain at date of death;” decedent uses excess over amount equal to step up at death] Also see §469(g)(2).
COD Income Rev Rul 92-92 – is PAGI if debt is PA CODI Exclusion of §108 List of tax attributes at 108(b) which must be reduced for excluded COD income includes PAL and PAC 45
§1398 and regs at §1.1398-1 Chapter 7 or 11 – suspended PAL and PAC Pass from debtor to bankruptcy estate 46
Amy rents out her Lake Tahoe cabin for 50 days in 2009 and uses it personally for 15 days. What rule applies to her loss?
Section 469 because it is a rental Section 280A because it meets the “use as a residence” test None of the above if the average rental period is 7 days or less D.
None of the above 47
Charles M. Akers, Jr.,
TC Memo 2010-85 2004 – T was sole owner of 3 cabin in CS Schedule E expenses of about $20K which IRS disallowed T hired Alpine, property mgmt company to rent the cabin in 2004 A to earn 35% commission on all rental income received A handled housekeeping and linens T maintained the property, paid utilities and “deep cleaned” the cabin 2x per year 2004 - cabin rented 3x for total of 12 days and 9 nights. T and IRS agree that average period of tenant use in 2004 was 3 days 2004 – T and family visited cabin 8x (27 days and 19 nights) T claimed these days were to perform repairs, but had no proof.
§469(i)(8) and regs With avg period of use of 3 days, is not a rental Thus, no §469(i) $25,000 loss offset Also, it trade or business, needs to prove material participation to have non-passive loss. T had no records to prove that he met any of the 7 MP tests.
§280A(c)(5) and (g) Dwelling unit is used as a residence if taxpayer’s personal use exceeds greater of 14 days or 10% of the fair rental days.
Since rented for less than 15 days, §280A(g) applies and no income to be reported, but also no expenses can be claimed other than those that go to Schedule A 49