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O  = 1HIRC 469  Passive Activities Part 1%%iBackground, purpose, basics, relevance in the tax law, some considerations in properly applying the rulesjjN BackgroundWidespread tax shelter investments by middle to high income taxpayers in 1980s Bluebook to TRA 86 page 210  Per Treasury,  in 1983, out of 260,000 tax returns reporting  total positive income in excess of $250,000, 11% paid taxes equaling 5% or less of total positive income, and 21% paid taxes equaling 10% or less of total positive income. Similarly, in the case of tax returns reporting total positive income in excess of $1 million, 11% paid tax equaling less than 5% of total positive income, and 19% paid tax equaling less than 10% of total positive income. In 1981, top individual rate was dropped from 70% to 50%..7P:P7:Purpose of the 469 rulesPer TRA 86 Blue Book (pages 209-214) Curb expansion of tax shelters. Only allow taxpayers with substantial and bona fide involvement in certain activities to deduct losses for the activity. Other taxpayers (passive ones) can only use losses against passive activity income or upon disposition when the  true economic benefit can be determined Prevent taxpayers from offsetting wage and investment income with passive losses. Provide limited relief to moderate income taxpayers with rental real estate activities. Prevent investment capital from being diverted from productive activities to tax shelter activities.^%PPPP% 469 GuidanceIRC and legislative histories Final and temporary regulations A few rulings and court cases Forms 8582 and 8801 and instructions are also helpful, as is IRS Pub 925 (but not primary authority)GWhat does 469 do?Only allows current year use of a deduction or credit from a  passive activity to be used against passive activity income or tax on such income. Any disallowed loss or credit for the year is carried forward to the next year and subject to the same PAL and PAC limitations. It is suspended. Generally, PAL  triggered if activity disposed of in a fully taxable transaction. So  prevents use of passive activity loss against non-passive income (such as wages and investment income).XPPP OBKey to application of the rules & \Activity is  passive if: T or B in which taxpayer does not materially participate. Any rental activity. Exceptions and special rules Rental real estate with active participation and AGI < $150,000. Real estate professional (added in 1993) Important  Meaning of:  activity  trade of business  rental  material participation Tracking of income, losses and suspended losses (and credits) of passive activities. Recordkeeping.POPPjP P PCPdPOj   C  d   +Early reaction to 469 and initial guidance,,&Is somewhat complicated due to length of rules, lots of definitions and special rules, and the grouping and recordkeeping needed to determine each passive activities PAL and PAC Letter reprinted in DTR 6/30/99  letter signed by  Disgusted called the temporary regulations  boring and incomprehensible and suggested that IRS should  throw them out altogether as unworkable and unenforceable.  And more & 2Friends of Oregon, et al v. Sec. of Treasury and IRS Comm r (DC Or 1988)  brought action to require IRS to prepare environmental impact study and to obtain court approval before adopting the 469 regs. Were concerned with the MP tests. Noted that regs encourage timber owners to convert timber lands to non-timber uses to get better tax result. Court disallowed claim for lack of subject matter jurisdiction6[?; ?>50 More reactionsConcerns that the rules hurt the real estate industry, such as Price declines (which also hurt local governments due to drop in property tax collections) Some say the rules helped fuel the subsequent S&L crisis&??MEconomic consequencesTestimony of Bill Archer, now with PWC, but formerly member and chair (1995-2001) of the House Ways & Means Committee 9/23/10 SFC hearing on lessons learned from TRA 86  The 1986 Act made a significant change to real estate investments on a retroactive basis, causing serious adverse consequences. I am referring to the passive loss rules that imposed restrictions on the deduction of losses from existing real estate investments. A number of economists and the Federal Reserve have cited this change as adversely impacting real estate values, which in turn contributed to the U.S. savings and loan crisis during the late 1980's and early 1990's. http://finance.senate.gov/hearings/hearing/?id=1d2a7636-5056-a032-5282-4bb7cf0d5078 \vPgPPv42$ 0H469 is in Subchapter EAccounting method? Notice 94-49   the passive activity rules may be viewed as character rules because they limit absorption of losses, or as timing rules because the losses ultimately will be absorbed St. Charles Investment Co. v. Commissioner, 110 T.C. 46 (1998), rev d on appeal Noted that while Congress did place 469 in Subchapter E, in the legislative history, it is explained under topic of  tax shelters rather than accounting methods (such as where 448 is discussed). TAM 201035016 --- Z ZZZZ*&  ITAM 201035016 &T says was MP in partnership in 1990  1994. IRS auditing 1994 and says did not MP in 1994. Asked National Office if  a recharacterization of the taxpayers' activities from nonpassive to passive for purposes of the passive activity loss and credit limit rules of 469 was a change in a  method of accounting for purposes of 446(e) and 481(a)? [Z[ R,x# JTAM 201035016 - more> Each year the taxpayers review their facts and decide whether during that year they materially participated in their nursing home activity. If the taxpayers did not materially participate, their nursing home activity must be classified as passive under the 469 rules. Based on the facts present in one year, the activity may be nonpassive in that year, while in another year, under the facts present in that year, the activity may be passive. Under the argument advocated by the examiner, each year that the activity changed from nonpassive to passive, or vice versa, the taxpayers would be required to file a Form 3115, Application for Change in Accounting Method. In each year of change, the taxpayers would be required to compute an adjustment under 481(a). If, for example, a taxpayer materially participated in an activity in 1997, but did not in 1998, the examiner would have the taxpayer file a Form 3115 for 1998. Any amounts that were properly deducted in 1997 because the activity was nonpassive, that would have been deferred had the activity been passive would be included in the computation under 481(a). Similarly, in the instant case, the examiner believes that if the taxpayers did not materially participate in 1994, the examiner may bring into income in 1994 any amounts that were deducted in prior years, that would not have been deductible in those years if the taxpayers had not materially participated in those years. The examiner believes that this may be done, by virtue of 481(a), without regard to whether the taxpayers materially participated in the nursing home activity in the prior years. The examiner notes that this is because, if a change from determining that a taxpayer materially participated in an activity to determining that it did not materially participate in the activity is a change in method of accounting, 481(a) authorizes necessary adjustments to prevent amounts from being duplicated or omitted. P @>J   K4TAM 201035016  conclusion We do not believe that a determination of whether a taxpayer materially participates in an activity is a method of accounting. In this case, the taxpayers' determination of whether they materially participate in their nursing home activity does not determine into which period an item of income or deduction will be placed. The taxpayers' determination does not involve the treatment of a  material item. Simply, determining whether the taxpayers materially participated in their activity for purposes of classifying the activity as passive or not is not an  item  it is not a recurring incidence of income or expense. Instead, the taxpayers' determination establishes the character of their activity for that year it is either passive or it is not passive. Once the character of the activity is determined, then if the activity is passive, the taxpayers must apply the statutorily mandated rules of 469 to any existing loss. So, if improperly applied MP in 1994, that is an error.  PLTAM 201035016 - commentsOdd ruling Statute is clear that MP is an annual determination, so whether an activity is passive or not can change from year to year. What is benefit of change from non-passive to passive being a method? Better question would be: T thought it met a MP test for past 6 years, but turns out did not. If method, 481(a) adjustment would bring past improperly claimed losses back into income. Notice 94-49 and St. Charles Investment Co. v. Commissioner, 110 T.C. 46 (1998) l  * Who is subject to 469TIndividuals Estates Trusts Closely-held C corporations Personal Service Corporations What is a passive activity?Either: A trade or business in which the taxpayer does not materially participate, or A rental activity (exception for real estate professionals at 469(c)(7)).nP@Activities specifically excluded from 469 loss limitation rulesAA&Working interests in oil and gas well 469(c)(3) & (4) and 1.469-1 t/p must have unlimited liability Rental of dwelling unit subject to 280A(c)(5) limitations 469(j)(10) and 1.469(e)(5) and 1.469-2(d)(2)(xii) Activity of trading personal property 1.469-1(e)(6)  (i) In general. An activity of trading personal property for the account of owners of interests in the activity is not a passive activity (without regard to whether such activity is a trade or business activity (within the meaning of paragraph (e)(2) of this section)). (ii) Personal property. For purposes of this paragraph (e)(6), the term  personal property means personal property (within the meaning of section 1092(d), without regard to paragraph (3) thereof). &P@P;P6P6PP&@;66  D T or B versus Rental Activity1.469-4(b)  (1) Trade or business activities. Trade or business activities are activities, other than rental activities or activities that are treated under 1.469-1T(e)(3)(vi)(B) as incidental to an activity of holding property for investment, that (i) Involve the conduct of a trade or business (within the meaning of section 162); (ii) Are conducted in anticipation of the commencement of a trade or business; or (iii) Involve research or experimental expenditures that are deductible under section 174 (or would be deductible if the taxpayer adopted the method described in section 174(a)). (2) Rental activities. Rental activities are activities that constitute rental activities within the meaning of 1.469-1T(e)(3). nZ_ZZ "_n Rental Activity`Generally, per 469(j)(6) and 1.469-1T(e): Involves tangible property used by customers or held for use by customers; and The gross income generated is from  amounts paid or to be paid principally for the use of such tangible property (without regard to whether the use of the property by customers is pursuant to a lease or pursuant to a service contract or other arrangement that is not denominated a lease). 6 exceptions exist6 Rental Exceptions1.469-1T(e) and -1(e) Average period of customer use < 7 days Average period of customer use < 30 days AND significant personal services provided Average period of customer use > 30 days and extraordinary personal services provided Rental incidental to a non-rental activity Property available during defined business hours for nonexclusive use by various customers Property provided by its owner for use in an activity of a p/s, S corp or joint venture in which the owner has an interest Exceptions must be applied each year.nPP&P6'&3,[ @ Average period of customer use FOriginal definition was changed by a later reg to avoid abuse. OLD definition: Aggregate # days in all period of customer use during TY # such periods of customer use NEW: weighs difference in rental value of the activity s property causing higher rental value property to have greater effect than lower rental value property Prevents t/p from lowering a longer rental period by short-term rentals of low value propertydOX^O9^,+!RExample of formula /BExample  Residential Care CenterrTAM 9247003  retirement center owned by ltd p/s. Q  rental or T or B? Centers provided all meals, maid service, laundry, recreational activities and transportation. Rental charge exceeded 2X cost of a luxury apt due to the services provided IRS Auditor  rental activity IRS National Office  what do you think?&22- 1HEX  Construction of rental propertyT was constructing and developing what would become rental property. Q  how to characterize the construction activity? TAM 9251003Material Participation2469(h)  exists when t/p  is involved in the operations of the activity on a basis which is (A) regular, (B) continuous, and (C) substantial. Ltd p/s   Except as provided in regulations, no interest in a limited partnership as a limited partner shall be treated as an interest with respect to which a taxpayer materially participates. Married taxpayers Include participation of each spouse to determine if either participates. Can be beneficial when want to be a MP, but detrimental when trying to not be a MP Regs. 1.469-5 and -5TBfPPPf>|kMaterial Participation TestsQuantitative Tests > 500 hours Participation constitutes substantially all of the participation in such activity of all individuals (including individuals who are not owners of interests in the activity) for such year Participation > 100 hours and is not less than participation of any other individual (including individuals who are not owners of interests in the activity) for such year; Significant participation activity (SPA) and aggregate participation in all SPAs during year > 500 hours Prior Year MP Tests MP in any 5 prior tax years (whether or not consecutive) during prior 10 years Personal service activity and individual materially participated in the activity for any 3 prior tax years (whether or not consecutive) Facts and Circumstances Test Based on all of facts and circumstances, individual participates in the activity on a regular, continuous, and substantial basis during the yearPnPPnPPnP  #MP definitions - SPA>Trade or business activity (1.469-1T(e)(2)) in which individual significantly participates for the year Would be an activity in which individual does not materially participate for the year if material participation for the year were determined without regard to the SPA rule. MP must exceed 100 hours for the year. +ExampleJessica owns following activities and participates as follows for 2010 A  Engineering business 1,600 hours B  Rental property 120 hours C  Fast food S corp 300 hours D  Video rental S corp 350 hours Analysis: A  not SPA because another MP test met B  not SPA because not a T or B (is a rental) C and D  SPA because > 100 hours and no other MP test met (assuming prior years MP test met for neither) AND total hours in SPAs > 500 Conclusion  Jessica is MP in A, C and DtGPP PP)PG )>1$TMP Definitions  Personal Service Activity++&Involves performance of personal services in (1) fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting; or (2) any other trade or business in which capital is not a material income-producing factor. 60vY&>MP  facts & circumstances test Facts and circumstances  reserved Hours must exceed 100 Certain management activities - individual's services performed in management of an activity are ignored in determining if he is material participant for F & C test UNLESS, for the year  (A) No person (other than such individual) who performs services in connection with the management of the activity receives compensation described in section 911(d)(2)(A) in consideration for such services; and (B) No individual performs services in connection with the management of the activity that exceed (by hours) the amount of such services performed by such individual. 1.469-5T(b)Z'*MP  limited partnersN1.469-5T(e) Can be MP if meet Test 1, 5 or 6 If also holds general partner interest: Don t treat as ltd partner for MP measurement purposes, so can meet any MP test &WQWQ( MP and LLCs Garnett v. Commissioner, 132 T.C. No. 19 (2009) Generally, interest held as limited partner is passive unless provided otherwise in regs. Regs allow ltd partner to meet material participation test if also GP or can use 3 of the 7 MP tests of 1.469-5 (> 500 hours, prior MP in 5/10 years, or personal service activity and MP in any prior 3 years) 469 enacted 1986; LLPs not around until 1991 IRS  owners of LLPs and LLCs have limited liability so should be treated similar as limited partners under 469 Court noted that 469(h)(2) is not that broad  says,   interest in a limited partnership as a limited partner  so, specific to ltd partnerships Conclusions: Partners did not hold their interests in certain LLPs and LLCs as  limited partners. Therefore, not subject to rule of presumed passive activity at 469(h)(2). Also, because partners'  interests in the tenancies in common are not interests in limited partnerships, these interests also are not subject to the rule of sec. 469(h)(2) Basically, legislative purpose of 469 better served by treating the LLP and LLC members as general partners. Thus, they can apply any of the 7 MP tests. Similarly  Thompson v. U.S., 104 AFTR 2d 2009-5381, (Ct Fed Cl), acq1PZPP?PPFPZ?   ) 3'%$ 0CAOD on Thompson case$  On July 20, 2009, the Court of Federal Claims issued a summary judgment opinion in Thompson v. U.S., 87 Fed. Cl. 728 (Fed. Cl. 2009), concluding that LLC interests are not  limited partnership interests for purposes of 1.469-5T(e)(3)(i). Thompson joined Garnett v. Commissioner , 132 T.C. 19 (2009) and Gregg v. U.S., 186 F. Supp. 2d 1123 (D. Or. 2000) as the third case to rule against the position that an interest in an LLC is a limited partnership interest under 1.469-5T(e)(3)(i). The taxpayer in Thompson directly owned 99% of an LLC that was in the airplane charter business. The taxpayer indirectly owned the remaining 1% interest through a wholly-owned S corporation. The Service disallowed losses that the taxpayer claimed arguing that the taxpayer failed to meet the restricted material participation requirements that applied to limited partners under 1.469-5T(e)(3)(i). Both parties stipulated that if the taxpayer's LLC interest was not characterized for purposes of 469 as a limited partnership interest then the taxpayer could establish material participation using any of the seven tests in 1.469-5T(a). The Court in Thompson held that the taxpayer's interest was not a limited partnership interest for purposes of 469, and that even if the interest was treated as an interest in a limited partnership, the taxpayer's interest would best be categorized as a general partnership interest under 1.469-5T(e)(3)(ii). Consequently, the Court held that the taxpayer could establish material participation using any of the seven tests in 1.469-5T(a). See also, Garnett and Gregg , supra. Recommendation Acquiesce in result only. yPT s  g|f _$ 0fg$ 0$ 0$ 0$ 06#Different Tax Years & MP ,1.469-2T(e)(1) Partnership has 9/30 year end Partner Tom wants to know if he meets a MP test. Q  does he look at calendar year or year ended 9/30/10?  MP RemindersMust check each year No prorating in quantitative tests for short years Participation of spouse counts  always ask what spouse does in the activity -5(f) and -5T(f): Must be work customarily done by an owner of such an activity; and One of the principal purposes for the performance of such work must not be to avoid the 469 rules Generally, work done in individual's capacity as an investor (studying financial statements, preparing financial analyses, monitoring finances or operations in a non-managerial capacity) in an activity is not counted unless the individual is directly involved in the day-to-day management or operations of the activity. .PP7$ MP QuestionJane provides legal services to partnership X as employee of law firm. Jane is also a 5% owner of X which manufacturer widgets. Q  Should Jane include her law firm hours serving X as part of her hours in determining if she is a material participant in X?) Proving MP1.469-5T(f)(4)   Methods of proof. The extent of an individual's participation in an activity may be established by any reasonable means. Contemporaneous daily time reports, logs, or similar documents are not required if the extent of such participation may be established by other reasonable means. Reasonable means for purposes of this paragraph may include but are not limited to the identification of services performed over a period of time and the approximate number of hours spent performing such services during such period, based on appointment books, calendars, or narrative summaries. Practical application? Have client keep records, particularly if close to an hour cut off point or has other full-time employmentDmZkZJk,`Q  can < 100 hours of participation ever be MP?11&fYes  substantially all test Prior years MP tests&00-PAL, PAGI, PAD and relevanced469(d)(1)  PAL = excess of aggregate losses from all passive activities for the year, over aggregate income from all passive activities for the year. So some netting involved, but must track PAL per activity so know how much suspended PAL might be triggered if activity disposed of PAGI - an item of gross income if and only if such income is from a passive activity PAD - if and only if such deduction  (i) Arises (within the meaning of paragraph (d)(8) of this section) in connection with the conduct of an activity that is a passive activity for the taxable year; or (ii) Is treated as a deduction from an activity under 1.469-1T(f)(4) for the taxable year. More details in -2 and -2T regs Special rules for gains from dispositions, portfolio and personal service income Ordering rules relevant if the loss is also subject to passthrough basis limitations, 465 and capital loss limitations (discussed later) Calculations on Form 8582PP|PP PPP| , a3 What is PAGI? 1.469-2T/Rules on portfolio and personal service income:004"PAGI QuestionsPartnership owns one rental property. Had CODI in 2009 of $40,000. Is it PAGI? Your client owns an apartment building and is required to keep security deposits in separate account. Earns $1,000 of interest income each year. Q  Portfolio or rental income? Client earns royalties from business of licensing movie rights? Q  Portfolio or trade/business income?hnZ Z@nZ)nZ @) 5!:PAGI  disposition gain rules`General rule -2T(c)(2)   Treatment of gain. Except as otherwise provided in the regulations under section 469, any gain recognized upon the sale, exchange, or other disposition (a  disposition ) of an interest in property used in an activity at the time of the disposition or of an interest in an activity held through a partnership or S corporation is treated in the following manner: (1) The gain is treated as gross income from such activity for the taxable year or years in which it is recognized; (2) If the activity is a passive activity of the taxpayer for the taxable year of the disposition, the gain is treated as passive activity gross income for the taxable year or years in which it is recognized; and (3) If the activity is not a passive activity of the taxpayer for the taxable year of the disposition, the gain is treated as not from a passive activity. Interest in p/s and S corp stock are not property used in a PA BPP@P@,}&;%Character of disposition gain1.469-2T(c) and -2(c) 12-month lookback rule  if property used in more than one activity in 12 months preceding disposition, gain characterized and allocated among the activities on a reasonable basis Substantially appreciated property rule  prop is SA if its FMV > 120% of its adj basis. If SA property previously used in a nonpassive activity, gain is NOT treated as passive unless property was used in a PA for either 20% of time it was held, or during the entire 24-month period ending on disposition date4PnP <&Disposition Question^T sells office building which he held for 3 years. During 12 months prior to sale, T used building 7 months as rental and 5 months in his business. Q - How to treat T s gain?>'Disposition Question Anne acquires building on 1/1/97 and uses it until 3/31/08 in a business activity in which Anne materially participates. On 4/1/08, Anne leases the building to Bob and on 12/31/09, sells it for $500,000. Adjusted basis = $200,000. Q  nature of disposition gain?@*:Income recharacterization rules -2T(f) and -2(f) SET 1;;&"Rules preventing conversion of active buisness income into PAGI: SPA rule (f)(2) Rental of self-developed property* (f)(5) Self-rented property rule* (f)(6) (self rental rule) * applies on property by property basis VAtnn)nAt*&A+9Income recharacterization rules -2T(f) and -2(f) SET 2::&!Rules preventing conversion of portfolio income into PAGI Rental of nondepreciable property (f)(8) Equity-financed lending activities (f)(4) Passthrough entities licensing intangible property* (f)(7) * applies on property by property basisV:nn(n:),D< ZF,-Authority for income recharacterization rules..&,Regulatory authority Congress gave to IRS at 469(l) Preserve intent of 469 Leg history:  to protect underlying purpose of the passive loss provision, i.e., preventing the sheltering of positive income sources through the use of tax losses derived from passive business activities. Without such rules, taxpayers would be encouraged to: Change participation levels Convert investment activities to passive@MEMEG- SPA -2T(f)(2)SPA  same definition as under -5T MP test If PAGI from all SPAs > PAD from such activities, net passive activity income treated as nonpassive activity income EX  T has 3 SPAs and aggregate hours are 400 SPA MP test not met, so passive If generate income, treated as non-passive IF t/p met the SPA MP test, the recharacterization rule would not apply (would not be subject to 469)VZ.ZKZgZ.Kg b<D k5_. SPA Example2008 SPA $1,000 income Rental $1,000 loss Result: report $1,000 active income and c/f $1,000 PAL 2009 SPA $1,000 loss Rental $1,000 loss Result: both losses are PALs and c/fL^J^J b/)Rental of self-developed property (f)(5)**&Net rental activity income not treated as PAI if, Any gain from disposition of property is included in income for the TY Property was rented out for less than 12 months prior to its disposition, and T materially or significantly participated in the value enhancement of the property,2q2d0:Self-rented property rule (f)(6) (self rental rule);;&Rental income from an item of property rented to a T or B in which T materially participates is treated as NOT from a PA EX  Al, a lawyer, rents office space to the law p/s in which he is a MP. If the rental activity generates income, it will not be PAI n/a if individual rents property to a CHC or PSC in which he is a stockholder because MP in the C corp is not relevant from the individual s perspective since the individual s only activity is owning stock which is not a PA,Z,zf1)Rental of nondepreciable property (f)(8)**& :Net passive activity income from activity of renting property is not treated as PAI if the unadjusted basis of the depreciable property is less than 30% of the unadjusted basis of all property rented in the activity. EX  rental of a parking lot where avg period of customer use > 30 days. If unadjusted basis is: Land $80,000 Pavement $20,000 The rule will apply if rental generates income because unadjusted basis of depreciable property ($20,000) is less than 30% of the unadjusted basis of all property rented in the activity ($100,000)<:PPP:g2)Equity-financed lending activities (f)(4)**&PPurpose  to prevent individuals, partnerships and S corps from becoming lenders in order to generate PAI when it would otherwise be portfolio income  Equity-financed lending activity  (1) involves T or B of lending money; and (2) avg outstanding balance of liabilities (deposits) incurred for the TY does not exceed 80% of avg outstanding balance of the interest-bearing assets (loans) held in the activity for the year*ZZ,Z^i3:Passthrough entities licensing intangible property (f)(7);;& 0"If T acquired interest after substantial development was completed, the royalty income is not PAI, but is recharacterized as portfolio income unless an exception is met: 1) expenditures reasonably incurred by development entity for TY with or within T s TY wrt development or marketing of such property, exceed 50% of the gross royalties from licensing such property; or 2) T s share of development or marketing expenditure for all TYs of entity beg with TY of entity in which T acquired interest and ending with TY of entity ending with or within T s current TY exceeds 25% of FMV of T s interest in such property at time T acquired interest in the entity..ZZ>jj4 Question 1aGeorge is a lawyer in a law p/s and rents office space to the p/s. What is the effect to George? ,!k5 Question 2Wilma owns: Video rental store 200 hours income Rental real estate 50 hours loss Acctg p/s 2,000 hours income Software consult 250 hours loss What is character of each activity  passive or active?< n8n ,Vpr8 Question 3Barbara is evaluating 3 different rental properties to acquire: Farm with 5,000 acres of land. The farmhouse would be rented out and the land rented out for cattle grazing. Barbara considers retiring there in about 10 years. Apartment building with 50 units. Mini-mall that she would construct, rent out for a few years and sell at a profit and use the money for retirement. Which is the better investment. B has 3 partnership interests that all produce PALs.L@7qUq@7Uo6 Question 4Is every individual s goal always to have passive activity income and active losses?B(Passive activity deductionDefine per 1.469-2T(d)C)PALOnce know the excess of PAD over PAGI (the  PAL ) you allocate it to loss activities using the allocation rules When a PAL carries forward, it must always be attached to an activity -1T(f)(2) Form 8582 and worksheets F469 s interaction with other rules5Included in Subchapter E of Chapter 1 1.469-1(e)(2) 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): Example. 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. \[PPP0(  !Ordering of loss limitation rules-2T(d)(6) and -1(d)(2) Ordering of loss limitation rules: Basis - 704(d) or 1366(d) At risk - 465 Passive activity - 469 Capital loss limitation - 1211,:dq:ds7469 and other rulesAMT 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 PADsL>>u9469 and more other rulesNOLs Blue Book pg 222 Prior year suspended PALs are used against current year PAI before NOL carryovers CODI Exclusion of 108 List of tax attributes at 108(b) which must be reduced for excluded COD income includes PAL and PACLcdcd$'}>!Residence rentals - 280A or 469VAmy 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 None of the above,zlz~?Rental residence case - factsCharles 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.(PPP<PEP=P@P<E=  ?@Holdingb469(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 P2PPPPP2      ,A>Flowchart  rental of residencex<"Spouses filing joint return -1T(j)fTreat as 1 t/p for 469 purposes Exceptions at -2T(j)(2) If stop filing MFJ PADs and PACs allocable to individual s activities for TY must be determined by taking into account items of deduction and credit attributable to individual s interest in Pas for immediately preceding TY Participation rule -5T(f)(3)6KK, =w: Activity -4B469 grouping guidanceRev. 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 . P^PrPwPPPP^r w   y;#Real Estate Professional 469(c)(7)=#469(c)(7) - Trask, TC Memo 2010-78 ($ && 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 Kosonen. TC Memo 2000-107. (3) materially participated in combined RRE activity. Thus, T s 2001 loss limited to $25K under 469(i). Similarly  see Anjum Shiekh, TC Memo 2010-126 Query  how to address this issue?PCPGPqPP7P5PSPCG q   7  E " PV,7E7469(c)(7) - "on call" time - Moss, 135 TC No.18 (2010) 68&&&&/ !"%* . 0 2 8 9:=?DEHIJKLMNOPQRST U!V"W#X$Y%Z&['\(])^*`+a,c-e.h/l0m1n2p3q4t5z6{7|89:;<=>?@ABCDE   0` 3333ff3` 3333f33ff3` "3333̙ff3` Kf3̙` &e̙3g3f` f333̙po7` ___f3̙;/f9` ff3Lm` ff3LmNLm>?" dd@*?nAd@q<nAqFLK#M n?" dd@   @@``PR    M`2p>> p(    H1? ?" `} 1 X Click to edit Master title style!!  @  H1? ?" ` 1 RClick to edit Master text styles Second level Third level Fourth level Fifth level!    S    6h1 #" `] `} 1 \*     61 #" ``  1 V*      6<1 #" `] `} 1 V*      C @ABCDE FjJ@3"0`B  s *DjJ"0 `0H  0޽h ? ___f3̙;/f9___PPT10i.  +D=' 7= @B + Edge  0  (     Hi? ?"@ i X Click to edit Master title style!!    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S 0 6( P   >*  0 6X    @* H 0 0޽h ? 3380___PPT10.ޔ:_ 8(    0P P%   >*   0Ъi  %  @*   6i P   >*   6i    @* H  0޽h ? 3380___PPT10.0  0  0(  x  c $i @ i x  c $i   i H  0޽h ? 3380___PPT10.ŔF;$ = 0  x$(  xr x S J} `}  } r x S T} ` } H x 0޽h ? ___f3̙;/f980___PPT10.hz$  0 ($(  (r ( S 8i `}  i r ( S i ` i H ( 0޽h ? ___f3̙;/f980___PPT10.Ŕp$  0 8$(  8r 8 S (i `}   r 8 S i ` i H 8 0޽h ? ___f3̙;/f980___PPT10.ޔ$ E 0 @ X$(  Xr X S HI `}   r X S < `  H X 0޽h ? ___f3̙;/f980___PPT10.:h$ D 0  $(  r  S  `}   r  S  `  H  0޽h ? ___f3̙;/f980___PPT10.hpQ$  0 <$(  <r < S pO `}   r < S \5 `  H < 0޽h ? ___f3̙;/f980___PPT10.ޔF$  0 D$(  Dr D S i `}   r D S i `  H D 0޽h ? ___f3̙;/f980___PPT10.ߔܡ\$  0 @$(  @r @ S T `}   r @ S Ha `  H @ 0޽h ? ___f3̙;/f980___PPT10.ߔp ,$ < 0  p$(  pr p S hc_ `}  _ r p S L2_ ` _ H p 0޽h ? ___f3̙;/f980___PPT10.hP,$ C 0 P \$(  \r \ S Do `}   r \ S | `  H \ 0޽h ? ___f3̙;/f980___PPT10.;hXͺ$ B 0 ` `$(  `r ` S l `}   r ` S 0 `  H ` 0޽h ? ___f3̙;/f980___PPT10.;h$ A 0 p d$(  dr d S H `}   r d S   `  H d 0޽h ? ___f3̙;/f980___PPT10.;h$ @ 0  h$(  hr h S  `}   r h S  `  H h 0޽h ? ___f3̙;/f980___PPT10. 0  $(  r  S  `}   r  S  `  H  0޽h ? ___f3̙;/f980___PPT10.hl$  0 `X$(  Xr X S Tҁ `}   r X S ,Ӂ `  H X 0޽h ? ___f3̙;/f980___PPT10.kL$  0 `$(  `r ` S  `}   r ` S  `  H ` 0޽h ? ___f3̙;/f980___PPT10.:  0 0L:(  Lr L S  `}    L S D0 `  "hu=H L 0޽h ? ___f3̙;/f980___PPT10. $  0 p$(  pr p S p `}   r p S H `  H p 0޽h ? ___f3̙;/f980___PPT10.2b  0 RJ0(  r  S  `}     TA ? p   0$P7 ,0  0\#`  FOld formula: 3000 2,035 = 1.47 average days New formula: 8.41 average days So new formula prevents t/p from converting something that meets the definition of a rental to a non-rental by also renting out a small value item for a very short time period. Taxpayer in example still needs to see if Rental Exception #2 is met.G0 2GhH  0޽h ? ___f3̙;/f980___PPT10.4xo$   0 $(  r  S H* `}   r  S  + `  H  0޽h ? ___f3̙;/f980___PPT10.D0{$   0 $(  r  S l1 `}   r  S D2 `  H  0޽h ? ___f3̙;/f980___PPT10.Fn9$  0 p$(  r  S \8 `}   r  S 49 `  H  0޽h ? ___f3̙;/f980___PPT10.=>:  0 :(  r  S TJ `}     S  T ``  "hu=H  0޽h ? ___f3̙;/f980___PPT10.=Q3$  0 $(  r  S ^ `}   r  S gi `  H  0޽h ? ___f3̙;/f980___PPT10.@6-$   0 @$(  r  S c `}   r  S d `  H  0޽h ? ___f3̙;/f980___PPT10.Bj$  0 $(  r  S li `}   r  S ni ` i H  0޽h ? ___f3̙;/f980___PPT10.@ok$  0 $(  r  S u `}   r  S xv `  H  0޽h ? ___f3̙;/f980___PPT10.@R#$  0 $(  r  S  `}   r  S ؁ `  H  0޽h ? ___f3̙;/f980___PPT10.A0 $  0 0$(  r  S $ `}   r  S 苗0 `P  H  0޽h ? ___f3̙;/f980___PPT10.AE$  0  H$(  Hr H S  `}   r H S ࡗ`  H H 0޽h ? ___f3̙;/f980___PPT10.Q_*$   0 $(  r  S $ `}   r  S  `  H  0޽h ? ___f3̙;/f980___PPT10.l@E$   0 $(  r  S L `}   r  S  `  H  0޽h ? ___f3̙;/f980___PPT10.>p'$  0 $(  r  S ϗ `}   r  S  `  H  0޽h ? ___f3̙;/f980___PPT10.l`jv$ ! 0 $(  r  S ֗ `}   r  S ֗ `  H  0޽h ? ___f3̙;/f980___PPT10.A@7$ " 0 `$(  r  S  `}   r  S @ `  H  0޽h ? ___f3̙;/f980___PPT10.C[$ # 0 p$(  r  S   `}   r  S   `0  H  0޽h ? ___f3̙;/f980___PPT10.C +Տ$ $ 0 $(  r  S  `}   r  S  `  H  0޽h ? ___f3̙;/f980___PPT10.H!>:  0 :(  r  S  `}     S L$ `  "hu=H  0޽h ? ___f3̙;/f980___PPT10.R$ % 0 $(  r  S p) `}   r  S H* `  H  0޽h ? ___f3̙;/f980___PPT10.Qp : & 0 @:(  r  S 9 `}     S h? `  "hu=H  0޽h ? ___f3̙;/f980___PPT10.uP)O$  0 P$(  r  S `E `}   r  S 8F `  H  0޽h ? ___f3̙;/f980___PPT10.u@E$  0 p$(  r  S N `}   r  S F `  H  0޽h ? ___f3̙;/f980___PPT10.vp::  0 ,:(  ,r , S U `}    , S l^ `  "hu=H , 0޽h ? ___f3̙;/f980___PPT10.y`Mh#: ' 0 0:(  0r 0 S h `}    0 S 0q `  "hu=H 0 0޽h ? ___f3̙;/f980___PPT10.y@Zjp$ * 0 P$(  r  S dx `}   r  S  500 hours  this level of involvement is unlikely to be a tax shelter 2 & 3. Substantially all  some activities might not require over 500 hours in a year 4. SPA  someone who devots over 500 hours per year to several activities, if each is an SPA, should be treated same as someone devoting time to just one activity 5 & 6. Prior years  per TD 8175 (1988)   an activity in which an individual has materially participated over a long period of time or a personal service activity in which an individual has participated for a substantial period of time is likely to represent the individual's principal livelihood rather than a passive investment. In particular, the Service does not believe that withdrawal from a longstanding active business or from a personal service business that has been active for a substantial period should convert an individual's earnings from the business to passive income. Thus, the Service believes the income from such businesses generally is part of the earned income base that section 469 was intended to protect. In the case of a longstanding active business (other than a personal service business), however, the Service believes that a continuing interest in such an activity is more appropriately viewed as an investment in a passive activity if the individual has not materially participated in the activity for a significant period of time during the 10-year period immediately preceding the taxable year. 7. No rationale given by IRS, but perhaps to not be as limiting as only having quantitative tests V H" "     VH  0޽h ? 3380___PPT10.>0Q 0 ZR(  ^  S 0(K   L  c $=0 0)   Could a janitorial services business be a PSA? Yes if labor intensive Regs do not define  capital is not a material income-producing factor  but look elsewhere such as 911, 1402, 1348 see if substnatial investment in inventories and assets US v Van Dyke, 696 F.2d 957 (Fed Cir)  taxidermy business  ct held that capital was NOT a MIPF eventhough needed some raw materials and machinery. Income was mostly produced by personal labor and skills >Hy  cH  0޽h ? 3380___PPT10.@UE 0 ~ (  ^  S 0(K   x  c $C0 0)   H  0޽h ? 3380___PPT10.A 0 ~P(  ^  S 0(K   x  c $H0 0)   Note  if Jessica did more than anyone else in Activity D, it would no longer be an SPA and so wound no longer be a MP in C H  0޽h ? 3380___PPT10.Bp 0 :2(  ^  S 0(K   ,  c $N0 0+    the gross income attributable to the conduct of the retirement centers during the taxable years represent amounts paid principally for the services provided rather than for the use of the tangible property. The residents' monthly payments were more than twice the cost of a luxury apartment. The difference between the residents' monthly payments and the value of the tangible property used by the residents represents the value of the services the residents received. These services include: three meals per day; tray service to the resident's apartment; weekly maid service; weekly laundering of bed and bath linens; on-site and off- site recreational activities; and transportation to town, doctors, and shopping. Therefore, the retirement centers were not rental activities under section 469(j)(8) of the Code or section 1.469- 1T(e)(3)(i) RC did not meet 2nd part of definition of a rental activity. Per -1T(e)(3)   (3) Rental activity. (i) In general. Except as otherwise provided in this paragraph (e)(3), an activity is a rental activity for a taxable year if (A) During such taxable year, tangible property held in connection with the activity is used by customers or held for use by customers; and (B) The gross income attributable to the conduct of the activity during such taxable year represents (or, in the case of an activity in which property is held for use by customers, the expected gross income from the conduct of the activity will represent) amounts paid or to be paid principally for the use of such tangible property (without regard to whether the use of the property by customers is pursuant to a lease or pursuant to a service contract or other arrangement that is not denominated a lease). So, rental exceptions not relevant here because it is not a rental activity. Is a T or B so next need to determine if T materially participated in order to know if it is a PA. BxZd  ;    6$ 0$ 046H  0޽h ? 3380___PPT10.Ew 0 (  ^  S 0(K     c $|S0 0)   tPer IRS in TAM 9251003   Assuming that the taxpayer MP in the activity during the years under examination, A s allocable share of the preconstruction expenses paid by the partnership is not characterized as a passive activity loss subject to the limitations of section 469 even though the final activity is a PA. H  0޽h ? 3380___PPT10.F9# 0 rj(  ^  S 0@D   d  c $Y0 0)   Use partnership or S corp year to measure MP Example from regs   A, a calendar year individual, is a partner in a partnership that has a taxable year ending January 31. During its taxable year ending on January 31, 1988, the partnership engages in a single trade or business activity. For the period from February 1, 1987, through January 31, 1988, A does not materially participate in this activity. In A's calendar year 1988 return, A's distributive share of the partnership's gross income and deductions from the activity must be treated as passive activity gross income and passive activity deductions, without regard to A's participation in the activity from February 1, 1988, through December 31, 1988. See also 1.469-11T(a)(4) (relating to the effective date of, and transition rules under, section 469 and the regulations thereunder). >" H  0޽h ? 3380___PPT10.lU/$ 0  "(  ^  S 0(K     c $|^0 0)   YES - -5(f)(1) 0 count work done in any capacity Does -5T(f)(2) apply to say we ignore it?  work not customarily done by owners?H  0޽h ? 3380___PPT10.t@" 0 ~0 (   ^   S 0(K   x   c $j0 0)   H   0޽h ? 3380___PPT10.t0e& 0 ~`(  ^  S 0(K   x  c $o0 0)   H  0޽h ? 3380___PPT10.uk ' 0 ~ (   ^   S 0(K   x   c $u0 0)   H   0޽h ? 3380___PPT10.vУk$* 0 44(  4^ 4 S 0(K    4 c $dz0 0)   *P H 4 0޽h ? 3380___PPT10.{A  0 ~8(  8^ 8 S 0(K   x 8 c $(0 0)   H 8 0޽h ? 3380___PPT10.{@ o 0 ~D(  D^ D S 0(K   x D c $0 0)   H D 0޽h ? 3380___PPT10.3 0 ~H(  H^ H S 0(K   x H c $ 0 0)   H H 0޽h ? 3380___PPT10.`)p 0 ~L(  L^ L S 0(K   x L c $0 0)   H L 0޽h ? 3380___PPT10.@y 0 ~ P(  P^ P S 0(K   x P c $ 0 0)   H P 0޽h ? 3380___PPT10.@c 0 ~0T(  T^ T S 0(K   x T c $0 0)   H T 0޽h ? 3380___PPT10. ٌY 0 @Xi(  X^ X S 0(K    X c $@0 0)   _KWith limited exceptions, such as for a working interest in oil and gas wellH X 0޽h ? 3380___PPT10.ğ  0 ~P\(  \^ \ S 0(K   x \ c $$0 0)   H \ 0޽h ? 3380___PPT10.ײ 0 ~``(  `^ ` S 0(K   x ` c $@0 0)   H ` 0޽h ? 3380___PPT10.`` 0 ~pd(  d^ d S 0(K   x d c $0 0)   H d 0޽h ? 3380___PPT10. 0 ~h(  h^ h S 0(K   x h c $@0 0)   H h 0޽h ? 3380___PPT10.] 0 ~l(  l^ l S 0(K   x l c $Ĝ0 0)   H l 0޽h ? 3380___PPT10.p$ 0 ~p(  p^ p S 0(K   x p c $@ʜ0 0)   H p 0޽h ? 3380___PPT10.p. 0 ~t(  t^ t S 0(K   x t c $Ϝ0 0)   H t 0޽h ? 3380___PPT10. A 0 ~x(  x^ x S 0(K   x x c $8՜0 0)   H x 0޽h ? 3380___PPT10.T 0 ~|(  |^ | S 0(K   x | c $]0 0)   H | 0޽h ? 3380___PPT10. 0 ~(  ^  S 0(K   x  c $X-0 0)   H  0޽h ? 3380___PPT10.(0  0 ~(  ^  S 0(K   x  c $X10 0)   H  0޽h ? 3380___PPT10.9! 0 ~(  ^  S 0(K   x  c $0 0)   H  0޽h ? 3380___PPT10.` 0 8"(  8X 8 C 0(K    8 S נ0 0)   $B  280AH 8 0޽h ? 3380___PPT10.Qp = 0 , $ D (  DX D C 0(K   $  D S  _0 0)p  XP___PPT92* ^ @  Under section 469(c)(7)(B), a taxpayer may qualify as a real estate professional and the rental real estate activity of the taxpayer is not a per se passive activity if: (i) More than one-half of the personal services performed in trades or businesses by the taxpayer during such taxable year are performed in real property trades or businesses in which the taxpayer materially participates, and (ii) such taxpayer performs more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates.  The extent of an individual's participation in an activity may be established by any reasonable means. Sec. 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988). This Court has acknowledged that although  reasonable means is interpreted broadly, a postevent  ballpark guesstimate will not suffice. See Lee v. Commissioner, T.C. Memo. 2006-193; Goshorn v. Commissioner, T.C. Memo. 1993-578. In addition, the Court recognizes that the temporary regulations cited above can be somewhat ambiguous concerning the records that a taxpayer needs to maintain. Goshorn v. Commissioner, supra. @8" h8h `} C$ 0H D 0޽h ? 3380___PPT10.QrBM 0  tR(  tX t C 0(K    t S _0 0)   T@Valid? Perhaps  relevant to tax principle of economic growth and efficiency Archer says he voted against TRA 86 because was concerned about its possible adverse and unknown economic effects. Note  there was a 4-year phase in of the PAL rules  1987 could still use 65% of your PAL against any income, then 40% in 1988, 20% in 1989 and 10% in 1990. However, the phase-in rules were not allowed for AMT purposes.H t 0޽h ? 3380___PPT10.h[IN 0 & |(  |X | C 0(K   } | S }0 0)  } Total positive income = salary, interest, dividends and income from profitable businesses and investments. Brought disrespect for tax system Lots of IRS audit timeH | 0޽h ? 3380___PPT10.hp-E P 0 t l  (  X  C 0(K   l   S p0 0)    Example of trading personal property from regs:  Example. A partnership is a trader of stocks, bonds, and other securities (within the meaning of section 1236(c)). The capital employed by the partnership in the trading activity consists of amounts contributed by the partners in exchange for their partnership interests, and funds borrowed by the partnership. The partnership derives gross income from the activity in the form of interest, dividends, and capital gains. Under these facts, the partnership is treated as conducting an activity of trading personal property for the account of its partners. Accordingly, under this paragraph (e)(6), the activity is not a passive activity.  I don t include RE Professional here because is really more of a special rule rather than an exception from the MP rules. That is, for the working interest exception noted on this slide, one does not need to show that it is a T or B or that the owner MPs, it is just excluded. In contrast, there are special rules that a RE Professional must meet to pull a rental from being an automatic passive activity. $J1 ,*H  0޽h ? 3380___PPT10.hIy,L 0 zr  (  X  C 0(K   }r  S }0 0)  } H  0޽h ? 3380___PPT10.hV.K 0 zr  (  X  C 0(K   }r  S <6}0 0)  } H  0޽h ? 3380___PPT10.hB.J 0 zr0  (  X  C 0(K   }r  S }0 0)  } H  0޽h ? 3380___PPT10.h.I 0 zr@  (  X  C 0(K   }r  S }0 0)  } H  0޽h ? 3380___PPT10.hT/H 0 zrP  (  X  C 0(K   }r  S O}0 0)  } H  0޽h ? 3380___PPT10.h?C/O 0 zr`  (  X  C 0(K   r  S  0 0)   H  0޽h ? 3380___PPT10.hC1G 0 zrp  (  X  C 0(K   _r  S _0 0)  _ H  0޽h ? 3380___PPT10.h 1rtIUgk]"ntxjNv@ V0#Ġ("-2^<@B^BNDl\GYnf]fiJkvmor&R t.v@>pF}rʃ{igjr  ( v |Oh+'0& hp    ,4 IRC 469 Passive ActivitiesAnnette NellenEdgeAnnette Nellen57Microsoft Office PowerPoint@Y@`JŔ@Moi GH%g  vv&WMFC"lx EMFQr F(GDICx!b $$==% % V0xx x % % $$AA" FGDICF(GDICrlvFGDICRp@Garamond̵Garamo䬾84@Garamo 0 d/|ŰXO08T%0|Űʰh˰L4TmTL|ŰpT$dv%    TTps0 B BsLP1 % ( F(GDIC &!b : $$==_888"̙% % W(1NNN N% % $$AA( : " FGDICF(GDIC"DF!b $$==_888̙% % W$ CG#NB N% % $$AA( " FGDICF(GDIC:FGDICRp@Garamond̵Ĝ̰.T̵I|Ű4|Ṵ̋|Űl*"TI\LʰL4|Űp\%0  ܀ 0s |Ű T|Űdv%    f3Td%(0 B B&LTIRC  % ( Rp@Arialnd̵|Űl*"TI\LʰL4|Űp\%0  ܀ 0s |Ű T|Ű%0$dv P$v\PwJ1~d,vvvxdv%    f3TT&+(0 B B&&LP % ( Rp@Garamond̵%0  ܀ 0s |Ű T|Ű%0$dv P$v\PwJ1~%0İvxdv P$vRwJ1~8 d,vvvxdv%    f3Td,>(0 B B,&LT469  % ( Rp@Garamond̵%0$dv P$v\PwJ1~%0İvxdv P$vRwJ1~8 %0dvxdv P$vTwJ1~P d,vvvxdv%    f3TT?D(0 B B?&LP } % ( Rp@Garamond̵%0İvxdv P$vRwJ1~8 %0dvxdv P$vTwJ1~P %0vxdv P$vVwJ1~xd,vvvxdv%    f3TH(0 B BH&LpPassive Activities % ( Rp@Garamond̵Garamo >84@Garamo 0 x/|ŰXO08T%0|Űʰh˰L4TmTL|ŰpT$dv%    f3TpF*^50 B BF3LXPart 1 % ( F(GDIC"DeFGDICRp@Arialq̵|Ű@˰|Ű̘B&T%lɰ@˰@˰8 $T%\'%0&h\@˰'T&h\Ⱥdv%    T8$HM0 B B$M'LBackground, purpose, basics, relevance  % ( Rp@Ariali̵|Ű@˰|Ű̘B&T%lɰ|Ű@˰@˰X $T%\'%0&h\@˰'T&h\Ⱥdv%    T8(OT0 B B(T'Lin the tax law, some considerations in k % ( Rp@ArialK̵Arial?84@Arial 0 /|ŰXO08T%0|Űʰh˰L4TmTL|ŰpT$dv%    T7W~\0 B B7\Lproperly applying the rules % (   x--$xx--'@Garamond?-.  2 s1."SystemMS Shell Dlg-̙-- % % --'̙--%"EE--'@Garamond?-. f3 2 &IRC .-@Arialnd?-. f3 2 &&.-@Garamond?-. f3 2 &,469 .-@Garamond?-. f3 2 &?.-@Garamond?-. f3"2 &HPassive Activities.-@Garamond?-. f32 3FPart 1.-@Arialq?-. 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O  =WHIRC 469  Passive Activities Part 1%%iBackground, purpose, basics, relevance in the tax law, some considerations in properly applying the rulesjjN BackgroundWidespread tax shelter investments by middle to high income taxpayers in 1980s Bluebook to TRA 86 page 210  Per Treasury,  in 1983, out of 260,000 tax returns reporting  total positive income in excess of $250,000, 11% paid taxes equaling 5% or less of total positive income, and 21% paid taxes equaling 10% or less of total positive income. Similarly, in the case of tax returns reporting total positive income in excess of $1 million, 11% paid tax equaling less than 5% of total positive income, and 19% paid tax equaling less than 10% of total positive income. In 1981, top individual rate was dropped from 70% to 50%..7P:P7:Purpose of the 469 rulesPer TRA 86 Blue Book (pages 209-214) Curb expansion of tax shelters. Only allow taxpayers with substantial and bona fide involvement in certain activities to deduct losses for the activity. Other taxpayers (passive ones) can only use losses against passive activity income or upon disposition when the  true economic benefit can be determined Prevent taxpayers from offsetting wage and investment income with passive losses. Provide limited relief to moderate income taxpayers with rental real estate activities. Prevent investment capital from being diverted from productive activities to tax shelter activities.^%PPPP% 469 GuidanceIRC and legislative histories Final and temporary regulations A few rulings and court cases Forms 8582 and 8801 and instructions are also helpful, as is IRS Pub 925 (but not primary authority)GWhat does 469 do?Only allows current year use of a deduction or credit from a  passive activity to be used against passive activity income or tax on such income. Any disallowed loss or credit for the year is carried forward to the next year and subject to the same PAL and PAC limitations. It is suspended. Generally, PAL  triggered if activity disposed of in a fully taxable transaction. So  prevents use of passive activity loss against non-passive income (such as wages and investment income).XPPP OBKey to application of the rules & \Activity is  passive if: T or B in which taxpayer does not materially participate. Any rental activity. Exceptions and special rules Rental real estate with active participation and AGI < $150,000. Real estate professional (added in 1993) Important  Meaning of:  activity  trade of business  rental  material participation Tracking of income, losses and suspended losses (and credits) of passive activities. Recordkeeping.POPPjP P PCPdPOj   C  d   +Early reaction to 469 and initial guidance,,&Is somewhat complicated due to length of rules, lots of definitions and special rules, and the grouping and recordkeeping needed to determine each passive activities PAL and PAC Letter reprinted in DTR 6/30/99  letter signed by  Disgusted called the temporary regulations  boring and incomprehensible and suggested that IRS should  throw them out altogether as unworkable and unenforceable.  And more & 2Friends of Oregon, et al v. Sec. of Treasury and IRS Comm r (DC Or 1988)  brought action to require IRS to prepare environmental impact study and to obtain court approval before adopting the 469 regs. Were concerned with the MP tests. Noted that regs encourage timber owners to convert timber lands to non-timber uses to get better tax result. Court disallowed claim for lack of subject matter jurisdiction6[?; ?>50 More reactionsConcerns that the rules hurt the real estate industry, such as Price declines (which also hurt local governments due to drop in property tax collections) Some say the rules helped fuel the subsequent S&L crisis&??MEconomic consequencesTestimony of Bill Archer, now with PWC, but formerly member and chair (1995-2001) of the House Ways & Means Committee 9/23/10 SFC hearing on lessons learned from TRA 86  The 1986 Act made a s      !"#$%&'()*+,-./0123456789:;<=>?@ABCDEFGHKLMNPQRSTUVWXYZ[\]^_`abcdefghijklmnopqrstuvwxyz{|}~ignificant change to real estate investments on a retroactive basis, causing serious adverse consequences. I am referring to the passive loss rules that imposed restrictions on the deduction of losses from existing real estate investments. A number of economists and the Federal Reserve have cited this change as adversely impacting real estate values, which in turn contributed to the U.S. savings and loan crisis during the late 1980's and early 1990's. http://finance.senate.gov/hearings/hearing/?id=1d2a7636-5056-a032-5282-4bb7cf0d5078 \vPgPPv42$ 0H469 is in Subchapter EAccounting method? Notice 94-49   the passive activity rules may be viewed as character rules because they limit absorption of losses, or as timing rules because the losses ultimately will be absorbed St. Charles Investment Co. v. Commissioner, 110 T.C. 46 (1998), rev d on appeal Noted that while Congress did place 469 in Subchapter E, in the legislative history, it is explained under topic of  tax shelters rather than accounting methods (such as where 448 is discussed). TAM 201035016 --- Z ZZZZ*&  ITAM 201035016 &T says was MP in partnership in 1990  1994. IRS auditing 1994 and says did not MP in 1994. Asked National Office if  a recharacterization of the taxpayers' activities from nonpassive to passive for purposes of the passive activity loss and credit limit rules of 469 was a change in a  method of accounting for purposes of 446(e) and 481(a)? [Z[ R,x# JTAM 201035016 - more> Each year the taxpayers review their facts and decide whether during that year they materially participated in their nursing home activity. If the taxpayers did not materially participate, their nursing home activity must be classified as passive under the 469 rules. Based on the facts present in one year, the activity may be nonpassive in that year, while in another year, under the facts present in that year, the activity may be passive. Under the argument advocated by the examiner, each year that the activity changed from nonpassive to passive, or vice versa, the taxpayers would be required to file a Form 3115, Application for Change in Accounting Method. In each year of change, the taxpayers would be required to compute an adjustment under 481(a). If, for example, a taxpayer materially participated in an activity in 1997, but did not in 1998, the examiner would have the taxpayer file a Form 3115 for 1998. Any amounts that were properly deducted in 1997 because the activity was nonpassive, that would have been deferred had the activity been passive would be included in the computation under 481(a). Similarly, in the instant case, the examiner believes that if the taxpayers did not materially participate in 1994, the examiner may bring into income in 1994 any amounts that were deducted in prior years, that would not have been deductible in those years if the taxpayers had not materially participated in those years. The examiner believes that this may be done, by virtue of 481(a), without regard to whether the taxpayers materially participated in the nursing home activity in the prior years. The examiner notes that this is because, if a change from determining that a taxpayer materially participated in an activity to determining that it did not materially participate in the activity is a change in method of accounting, 481(a) authorizes necessary adjustments to prevent amounts from being duplicated or omitted. P @>J   K4TAM 201035016  conclusion We do not believe that a determination of whether a taxpayer materially participates in an activity is a method of accounting. In this case, the taxpayers' determination of whether they materially participate in their nursing home activity does not determine into which period an item of income or deduction will be placed. The taxpayers' determination does not involve the treatment of a  material item. Simply, determining whether the taxpayers materially participated in their activity for purposes of classifying the activity as passive or not is not an  item  it is not a recurring incidence of income or expense. Instead, the taxpayers' determination establishes the character of their activity for that year it is either passive or it is not passive. Once the character of the activity is determined, then if the activity is passive, the taxpayers must apply the statutorily mandated rules of 469 to any existing loss. So, if improperly applied MP in 1994, that is an error.  PLTAM 201035016 - commentsOdd ruling Statute is clear that MP is an annual determination, so whether an activity is passive or not can change from year to year. What is benefit of change from non-passive to passive being a method? Better question would be: T thought it met a MP test for past 6 years, but turns out did not. If method, 481(a) adjustment would bring past improperly claimed losses back into income. Notice 94-49 and St. Charles Investment Co. v. Commissioner, 110 T.C. 46 (1998) l  * Who is subject to 469TIndividuals Estates Trusts Closely-held C corporations Personal Service Corporations What is a passive activity?Either: A trade or business in which the taxpayer does not materially participate, or A rental activity (exception for real estate professionals at 469(c)(7)).nP@Activities specifically excluded from 469 loss limitation rulesAA&Working interests in oil and gas well 469(c)(3) & (4) and 1.469-1 t/p must have unlimited liability Rental of dwelling unit subject to 280A(c)(5) limitations 469(j)(10) and 1.469(e)(5) and 1.469-2(d)(2)(xii) Activity of trading personal property 1.469-1(e)(6)  (i) In general. An activity of trading personal property for the account of owners of interests in the activity is not a passive activity (without regard to whether such activity is a trade or business activity (within the meaning of paragraph (e)(2) of this section)). (ii) Personal property. For purposes of this paragraph (e)(6), the term  personal property means personal property (within the meaning of section 1092(d), without regard to paragraph (3) thereof). &P@P;P6P6PP&@;66  D T or B versus Rental Activity1.469-4(b)  (1) Trade or business activities. Trade or business activities are activities, other than rental activities or activities that are treated under 1.469-1T(e)(3)(vi)(B) as incidental to an activity of holding property for investment, that (i) Involve the conduct of a trade or business (within the meaning of section 162); (ii) Are conducted in anticipation of the commencement of a trade or business; or (iii) Involve research or experimental expenditures that are deductible under section 174 (or would be deductible if the taxpayer adopted the method described in section 174(a)). (2) Rental activities. Rental activities are activities that constitute rental activities within the meaning of 1.469-1T(e)(3). nZ_ZZ "_n Rental Activity`Generally, per 469(j)(6) and 1.469-1T(e): Involves tangible property used by customers or held for use by customers; and The gross income generated is from  amounts paid or to be paid principally for the use of such tangible property (without regard to whether the use of the property by customers is pursuant to a lease or pursuant to a service contract or other arrangement that is not denominated a lease). 6 exceptions exist6 Rental Exceptions1.469-1T(e) and -1(e) Average period of customer use < 7 days Average period of customer use < 30 days AND significant personal services provided Average period of customer use > 30 days and extraordinary personal services provided Rental incidental to a non-rental activity Property available during defined business hours for nonexclusive use by various customers Property provided by its owner for use in an activity of a p/s, S corp or joint venture in which the owner has an interest Exceptions must be applied each year.nPP&P6'&3,[ @ Average period of customer use FOriginal definition was changed by a later reg to avoid abuse. OLD definition: Aggregate # days in all period of customer use during TY # such periods of customer use NEW: weighs difference in rental value of the activity s property causing higher rental value property to have greater effect than lower rental value property Prevents t/p from lowering a longer rental period by short-term rentals of low value propertydOX^O9^,+!RExample of formula /BExample  Residential Care CenterrTAM 9247003  retirement center owned by ltd p/s. Q  rental or T or B? Centers provided all meals, maid service, laundry, recreational activities and transportation. Rental charge exceeded 2X cost of a luxury apt due to the services provided IRS Auditor  rental activity IRS National Office  what do you think?&22- 1HEX  Construction of rental propertyT was constructing and developing what would become rental property. Q  how to characterize the construction activity? TAM 9251003Material Participation2469(h)  exists when t/p  is involved in the operations of the activity on a basis which is (A) regular, (B) continuous, and (C) substantial. Ltd p/s   Except as provided in regulations, no interest in a limited partnership as a limited partner shall be treated as an interest with respect to which a taxpayer materially participates. Married taxpayers Include participation of each spouse to determine if either participates. Can be beneficial when want to be a MP, but detrimental when trying to not be a MP Regs. 1.469-5 and -5TBfPPPf>|kMaterial Participation TestsQuantitative Tests > 500 hours Participation constitutes substantially all of the participation in such activity of all individuals (including individuals who are not owners of interests in the activity) for such year Participation > 100 hours and is not less than participation of any other individual (including individuals who are not owners of interests in the activity) for such year; Significant participation activity (SPA) and aggregate participation in all SPAs during year > 500 hours Prior Year MP Tests MP in any 5 prior tax years (whether or not consecutive) during prior 10 years Personal service activity and individual materially participated in the activity for any 3 prior tax years (whether or not consecutive) Facts and Circumstances Test Based on all of facts and circumstances, individual participates in the activity on a regular, continuous, and substantial basis during the yearPnPPnPPnP  #MP definitions - SPA>Trade or business activity (1.469-1T(e)(2)) in which individual significantly participates for the year Would be an activity in which individual does not materially participate for the year if material participation for the year were determined without regard to the SPA rule. MP must exceed 100 hours for the year. +ExampleJessica owns following activities and participates as follows for 2010 A  Engineering business 1,600 hours B  Rental property 120 hours C  Fast food S corp 300 hours D  Video rental S corp 350 hours Analysis: A  not SPA because another MP test met B  not SPA because not a T or B (is a rental) C and D  SPA because > 100 hours and no other MP test met (assuming prior years MP test met for neither) AND total hours in SPAs > 500 Conclusion  Jessica is MP in A, C and DtGPP PP)PG )>1$TMP Definitions  Personal Service Activity++&Involves performance of personal services in (1) fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting; or (2) any other trade or business in which capital is not a material income-producing factor. 60vY&>MP  facts & circumstances test Facts and circumstances  reserved Hours must exceed 100 Certain management activities - individual's services performed in management of an activity are ignored in determining if he is material participant for F & C test UNLESS, for the year  (A) No person (other than such individual) who performs services in connection with the management of the activity receives compensation described in section 911(d)(2)(A) in consideration for such services; and (B) No individual performs services in connection with the management of the activity that exceed (by hours) the amount of such services performed by such individual. 1.469-5T(b)Z'*MP  limited partnersN1.469-5T(e) Can be MP if meet Test 1, 5 or 6 If also holds general partner interest: Don t treat as ltd partner for MP measurement purposes, so can meet any MP test &WQWQ( MP and LLCs Garnett v. Commissioner, 132 T.C. No. 19 (2009) Generally, interest held as limited partner is passive unless provided otherwise in regs. Regs allow ltd partner to meet material participation test if also GP or can use 3 of the 7 MP tests of 1.469-5 (> 500 hours, prior MP in 5/10 years, or personal service activity and MP in any prior 3 years) 469 enacted 1986; LLPs not around until 1991 IRS  owners of LLPs and LLCs have limited liability so should be treated similar as limited partners under 469 Court noted that 469(h)(2) is not that broad  says,   interest in a limited partnership as a limited partner  so, specific to ltd partnerships Conclusions: Partners did not hold their interests in certain LLPs and LLCs as  limited partners. Therefore, not subject to rule of presumed passive activity at 469(h)(2). Also, because partners'  interests in the tenancies in common are not interests in limited partnerships, these interests also are not subject to the rule of sec. 469(h)(2) Basically, legislative purpose of 469 better served by treating the LLP and LLC members as general partners. Thus, they can apply any of the 7 MP tests. Similarly  Thompson v. U.S., 104 AFTR 2d 2009-5381, (Ct Fed Cl), acq1PZPP?PPFPZ?   ) 3'%$ 0CAOD on Thompson case$  On July 20, 2009, the Court of Federal Claims issued a summary judgment opinion in Thompson v. U.S., 87 Fed. Cl. 728 (Fed. Cl. 2009), concluding that LLC interests are not  limited partnership interests for purposes of 1.469-5T(e)(3)(i). Thompson joined Garnett v. Commissioner , 132 T.C. 19 (2009) and Gregg v. U.S., 186 F. Supp. 2d 1123 (D. Or. 2000) as the third case to rule against the position that an interest in an LLC is a limited partnership interest under 1.469-5T(e)(3)(i). The taxpayer in Thompson directly owned 99% of an LLC that was in the airplane charter business. The taxpayer indirectly owned the remaining 1% interest through a wholly-owned S corporation. The Service disallowed losses that the taxpayer claimed arguing that the taxpayer failed to meet the restricted material participation requirements that applied to limited partners under 1.469-5T(e)(3)(i). Both parties stipulated that if the taxpayer's LLC interest was not characterized for purposes of 469 as a limited partnership interest then the taxpayer could establish material participation using any of the seven tests in 1.469-5T(a). The Court in Thompson held that the taxpayer's interest was not a limited partnership interest for purposes of 469, and that even if the interest was treated as an interest in a limited partnership, the taxpayer's interest would best be categorized as a general partnership interest under 1.469-5T(e)(3)(ii). Consequently, the Court held that the taxpayer could establish material participation using any of the seven tests in 1.469-5T(a). See also, Garnett and Gregg , supra. Recommendation Acquiesce in result only. yPT s  g|f _$ 0fg$ 0$ 0$ 0$ 06#Different Tax Years & MP ,1.469-2T(e)(1) Partnership has 9/30 year end Partner Tom wants to know if he meets a MP test. Q  does he look at calendar year or year ended 9/30/10?  MP RemindersMust check each year No prorating in quantitative tests for short years Participation of spouse counts  always ask what spouse does in the activity -5(f) and -5T(f): Must be work customarily done by an owner of such an activity; and One of the principal purposes for the performance of such work must not be to avoid the 469 rules Generally, work done in individual's capacity as an investor (studying financial statements, preparing financial analyses, monitoring finances or operations in a non-managerial capacity) in an activity is not counted unless the individual is directly involved in the day-to-day management or operations of the activity. .PP7$ MP QuestionJane provides legal services to partnership X as employee of law firm. Jane is also a 5% owner of X which manufacturer widgets. Q  Should Jane include her law firm hours serving X as part of her hours in determining if she is a material participant in X?) Proving MP1.469-5T(f)(4)   Methods of proof. The extent of an individual's participation in an activity may be established by any reasonable means. Contemporaneous daily time reports, logs, or similar documents are not required if the extent of such participation may be established by other reasonable means. Reasonable means for purposes of this paragraph may include but are not limited to the identification of services performed over a period of time and the approximate number of hours spent performing such services during such period, based on appointment books, calendars, or narrative summaries. Practical application? Have client keep records, particularly if close to an hour cut off point or has other full-time employmentDmZkZJk,`Q  can < 100 hours of participation ever be MP?11&fYes  substantially all test Prior years MP tests&00QNextQuiz on Desire 2 Learn Then & Podcast going over the examples in regs on rental exceptions and material participation Powerpoint presentation on more rules in 469 including definition of  activity, measurements of PAL and PAI, recharacterization rules, and more!&Z1 d/( !"%* . 0 2 8 9HIJKLMNOPQRST U!V"<=>?@ABCDE$  0  $(  r  S j `}   r  S  `  H  0޽h ? ___f3̙;/f980___PPT10.h=rLQ x ( v |    ՜.+,D՜.+,D    On-screen Showwr)'' .Arial GaramondTimes New Roman WingdingsEdge%IRC 469 Passive Activities Part 1 BackgroundPurpose of the 469 rules469 GuidanceWhat does 469 do?"Key to application of the rules ,Early reaction to 469 and initial guidance And more More reactionsEconomic consequences469 is in Subchapter ETAM 201035016 TAM 201035016 - moreTAM 201035016 conclusionTAM 201035016 - commentsWho is subject to 469What is a passive activity?AActivities specifically excluded from 469 loss limitation rulesT or B versus Rental ActivityRental Activity6 Rental Exceptions!Average period of customer useExample of formula"Example Residential Care Center%EX Construction of rental propertyMaterial ParticipationMaterial Participation TestsMP definitions - SPAExample+MP Definitions Personal Service Activity MP facts & circumstances testMP limited partners MP and LLCsAOD on Thompson caseDifferent Tax Years & MP MP Reminders MP Question Proving MP1Q can < 100 hours of participation ever be MP?Q are MP regs valid?Next  Fonts UsedDesign Template Slide Titles)( 8@ _PID_HLINKSAThttp://finance.senate.gov/hearings/hearing/?id=1d2a7636-5056-a032-5282-4bb7cf0d5078&_SrpAnnette NellenAnnette Nellenom/getDoc?DocID=T0TCODE:11186.1&pinpnt=TCODE:11244.1=https://checkpoint.riag.com/getDoc?DocID=T0TCODE:7.1&pinpnt=&_Annette NellenAnnette NellenDrmI.jv)6a)#Q1ٳP)!Rrpɞ5.A>ׂ550|md?b,fիJ#YRU?MXO H)ج݋33H KPRCe%{| %I6׫K H(i`Л8IXj9.@fPSsR3tYj˚AZ}$s[ 5ot^Dyҹ }RߠAUZ3]MV3oqidU[z%3|C:AnwdNg~VٻL:Rk덼Ѭ;}?2?$ fu:/"0A*(jlz{˗/IXjd& Ne`_}%t`Pjl#;80(F^w >-MCr: 9DjQ0G[G lVK|̀Mh4>ا NWoo naeeE Hp /X1g@3ZƘAUo]=|3v1A4 ~7^N6gg^={<iAEem4N0fr q C23p$ VTt)W(Y"(4K {51gj3# ",IwѣZ3/02k  %$gDLHZH)ezzzF؜LNNHL¯)fY̠ AH/z  -¿TďÌ3x\V.#Q.K؜H*\]1 3xb%;f ?}PZ 3Ua_30 3VD"g7Mvt̀^̠I̠zqn x__!376HrbKKsS؜֭27~,)Mjg<3X|3a! 4CuȻ̠9+>3(/"&o5:z?JK-Aem}=F oM %O=AJjCxt5@$x!t:9+>3{5J;P̘Cm$307Y,oVW AK$r>ۧ$愲:䀴0<<"1*asV|fϷXRNܹ[(Y<*)H6s $oD k> /="aN]wo? 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O  =AHIRC 469  Passive Activities Part 1%%iBackground, purpose, basics, relevance in the tax law, some considerations in properly applying the rulesjjN BackgroundWidespread tax shelter investments by middle to high income taxpayers in 1980s Bluebook to TRA 86 page 210  Per Treasury,  in 1983, out of 260,000 tax returns reporting  total positive income in excess of $250,000, 11% paid taxes equaling 5% or less of total positive income, and 21% paid taxes equaling 10% or less of total positive income. Similarly, in the case of tax returns reporting total positive income in excess of $1 million, 11% paid tax equaling less than 5% of total positive income, and 19% paid tax equaling less than 10% of total positive income. In 1981, top individual rate was dropped from 70% to 50%..7P:P7:Purpose of the 469 rulesPer TRA 86 Blue Book (pages 209-214) Curb expansion of tax shelters. Only allow taxpayers with substantial and bona fide involvement in certain activities to deduct losses for the activity. Other taxpayers (passive ones) can only use losses against passive activity income or upon disposition when the  true economic benefit can be determined Prevent taxpayers from offsetting wage and investment income with passive losses. Provide limited relief to moderate income taxpayers with rental real estate activities. Prevent investment capital from being diverted from productive activities to tax shelter activities.^%PPPP% 469 GuidanceIRC and legislative histories Final and temporary regulations A few rulings and court cases Forms 8582 and 8801 and instructions are also helpful, as is IRS Pub 925 (but not primary authority)GWhat does 469 do?Only allows current year use of a deduction or credit from a  passive activity to be used against passive activity income or tax on such income. Any disallowed loss or credit for the year is carried forward to the next year and subject to the same PAL and PAC limitations. It is suspended. Generally, PAL  triggered if activity disposed of in a fully taxable transaction. So  prevents use of passive activity loss against non-passive income (such as wages and investment income).XPPP OBKey to application of the rules & \Activity is  passive if: T or B in which taxpayer does not materially participate. Any rental activity. Exceptions and special rules Rental real estate with active participation and AGI < $150,000. Real estate professional (added in 1993) Important  Meaning of:  activity  trade of business  rental  material participation Tracking of income, losses and suspended losses (and credits) of passive activities. Recordkeeping.POPPjP P PCPdPOj   C  d   +Early reaction to 469 and initial guidance,,&Is somewhat complicated due to length of rules, lots of definitions and special rules, and the grouping and recordkeeping needed to determine each passive activities PAL and PAC Letter reprinted in DTR 6/30/99  letter signed by  Disgusted called the temporary regulations  boring and incomprehensible and suggested that IRS should  throw them out altogether as unworkable and unenforceable.  And more & 2Friends of Oregon, et al v. Sec. of Treasury and IRS Comm r (DC Or 1988)  brought action to require IRS to prepare environmental impact study and to obtain court approval before adopting the 469 regs. Were concerned with the MP tests. Noted that regs encourage timber owners to convert timber lands to non-timber uses to get better tax result. Court disallowed claim for lack of subject matter jurisdiction6[?; ?>50 More reactionsConcerns that the rules hurt the real estate industry, such as Price declines (which also hurt local governments due to drop in property tax collections) Some say the rules helped fuel the subsequent S&L crisis&??MEconomic consequencesTestimony of Bill Archer, now with PWC, but formerly member and chair (1995-2001) of the House Ways & Means Committee 9/23/10 SFC hearing on lessons learned from TRA 86  The 1986 Act made a significant change to real estate investments on a retroactive basis, causing serious adverse consequences. I am referring to the passive loss rules that imposed restrictions on the deduction of losses from existing real estate investments. A number of economists and the Federal Reserve have cited this change as adversely impacting real estate values, which in turn contributed to the U.S. savings and loan crisis during the late 1980's and early 1990's. http://finance.senate.gov/hearings/hearing/?id=1d2a7636-5056-a032-5282-4bb7cf0d5078 \vPgPPv42$ 0H469 is in Subchapter EAccounting method? Notice 94-49   the passive activity rules may be viewed as character rules because they limit absorption of losses, or as timing rules because the losses ultimately will be absorbed St. Charles Investment Co. v. Commissioner, 110 T.C. 46 (1998), rev d on appeal Noted that while Congress did place 469 in Subchapter E, in the legislative history, it is explained under topic of  tax shelters rather than accounting methods (such as where 448 is discussed). TAM 201035016 --- Z ZZZZ*&  ITAM 201035016 &T says was MP in partnership in 1990  1994. IRS auditing 1994 and says did not MP in 1994. Asked National Office if  a recharacterization of the taxpayers' activities from nonpassive to passive for purposes of the passive activity loss and credit limit rules of 469 was a change in a  method of accounting for purposes of 446(e) and 481(a)? [Z[ R,x# JTAM 201035016 - more> Each year the taxpayers review their facts and decide whether during that year they materially participated in their nursing home activity. If the taxpayers did not materially participate, their nursing home activity must be classified as passive under the 469 rules. Based on the facts present in one year, the activity may be nonpassive in that year, while in another year, under the facts present in that year, the activity may be passive. Under the argument advocated by the examiner, each year that the activity changed from nonpassive to passive, or vice versa, the taxpayers would be required to file a Form 3115, Application for Change in Accounting Method. In each year of change, the taxpayers would be required to compute an adjustment under 481(a). If, for example, a taxpayer materially participated in an activity in 1997, but did not in 1998, the examiner would have the taxpayer file a Form 3115 for 1998. Any amounts that were properly deducted in 1997 because the activity was nonpassive, that would have been deferred had the activity been passive would be included in the computation under 481(a). Similarly, in the instant case, the examiner believes that if the taxpayers did not materially participate in 1994, the examiner may bring into income in 1994 any amounts that were deducted in prior years, that would not have been deductible in those years if the taxpayers had not materially participated in those years. The examiner believes that this may be done, by virtue of 481(a), without regard to whether the taxpayers materially participated in the nursing home activity in the prior years. The examiner notes that this is because, if a change from determining that a taxpayer materially participated in an activity to determining that it did not materially participate in the activity is a change in method of accounting, 481(a) authorizes necessary adjustments to prevent amounts from being duplicated or omitted. P @>J   K4TAM 201035016  conclusion We do not believe that a determination of whether a taxpayer materially participates in an activity is a method of accounting. In this case, the taxpayers' determination of whether they materially participate in their nursing home activity does not determine into which period an item of income or deduction will be placed. The taxpayers' determination does not involve the treatment of a  material item. Simply, determining whether the taxpayers materially participated in their activity for purposes of classifying the activity as passive or not is not an  item  it is not a recurring incidence of income or expense. Instead, the taxpayers' determination establishes the character of their activity for that year it is either passive or it is not passive. Once the character of the activity is determined, then if the activity is passive, the taxpayers must apply the statutorily mandated rules of 469 to any existing loss. So, if improperly applied MP in 1994, that is an error.  PLTAM 201035016 - commentsOdd ruling Statute is clear that MP is an annual determination, so whether an activity is passive or not can change from year to year. What is benefit of change from non-passive to passive being a method? Better question would be: T thought it met a MP test for past 6 years, but turns out did not. If method, 481(a) adjustment would bring past improperly claimed losses back into income. Notice 94-49 and St. Charles Investment Co. v. Commissioner, 110 T.C. 46 (1998) l  * Who is subject to 469TIndividuals Estates Trusts Closely-held C corporations Personal Service Corporations What is a passive activity?Either: A trade or business in which the taxpayer does not materially participate, or A rental activity (exception for real estate professionals at 469(c)(7)).nP@Activities specifically excluded from 469 loss limitation rulesAA&Working interests in oil and gas well 469(c)(3) & (4) and 1.469-1 t/p must have unlimited liability Rental of dwelling unit subject to 280A(c)(5) limitations 469(j)(10) and 1.469(e)(5) and 1.469-2(d)(2)(xii) Activity of trading personal property 1.469-1(e)(6)  (i) In general. An activity of trading personal property for the account of owners of interests in the activity is not a passive activity (without regard to whether such activity is a trade or business activity (within the meaning of paragraph (e)(2) of this section)). (ii) Personal property. For purposes of this paragraph (e)(6), the term  personal property means personal property (within the meaning of section 1092(d), without regard to paragraph (3) thereof). &P@P;P6P6PP&@;66  D T or B versus Rental Activity1.469-4(b)  (1) Trade or business activities. Trade or business activities are activities, other than rental activities or activities that are treated under 1.469-1T(e)(3)(vi)(B) as incidental to an activity of holding property for investment, that (i) Involve the conduct of a trade or business (within the meaning of section 162); (ii) Are conducted in anticipation of the commencement of a trade or business; or (iii) Involve research or experimental expenditures that are deductible under section 174 (or would be deductible if the taxpayer adopted the method described in section 174(a)). (2) Rental activities. Rental activities are activities that constitute rental activities within the meaning of 1.469-1T(e)(3). nZ_ZZ "_n Rental Activity`Generally, per 469(j)(6) and 1.469-1T(e): Involves tangible property used by customers or held for use by customers; and The gross income generated is from  amounts paid or to be paid principally for the use of such tangible property (without regard to whether the use of the property by customers is pursuant to a lease or pursuant to a service contract or other arrangement that is not denominated a lease). 6 exceptions exist6 Rental Exceptions1.469-1T(e) and -1(e) Average period of customer use < 7 days Average period of customer use < 30 days AND significant personal services provided Average period of customer use > 30 days and extraordinary personal services provided Rental incidental to a non-rental activity Property available during defined business hours for nonexclusive use by various customers Property provided by its owner for use in an activity of a p/s, S corp or joint venture in which the owner has an interest Exceptions must be applied each year.nPP&P6'&3,[ @ Average period of customer use FOriginal definition was changed by a later reg to avoid abuse. OLD definition: Aggregate # days in all period of customer use during TY # such periods of customer use NEW: weighs difference in rental value of the activity s property causing higher rental value property to have greater effect than lower rental value property Prevents t/p from lowering a longer rental period by short-term rentals of low value propertydOX^O9^,+!RExample of formula /BExample  Residential Care CenterrTAM 9247003  retirement center owned by ltd p/s. Q  rental or T or B? Centers provided all meals, maid service, laundry, recreational activities and transportation. Rental charge exceeded 2X cost of a luxury apt due to the services provided IRS Auditor  rental activity IRS National Office  what do you think?&22- 1HEX  Construction of rental propertyT was constructing and developing what would become rental property. Q  how to characterize the construction activity? TAM 9251003Material Participation2469(h)  exists when t/p  is involved in the operations of the activity on a basis which is (A) regular, (B) continuous, and (C) substantial. Ltd p/s   Except as provided in regulations, no interest in a limited partnership as a limited partner shall be treated as an interest with respect to which a taxpayer materially participates. Married taxpayers Include participation of each spouse to determine if either participates. Can be beneficial when want to be a MP, but detrimental when trying to not be a MP Regs. 1.469-5 and -5TBfPPPf>|kMaterial Participation TestsQuantitative Tests > 500 hours Participation constitutes substantially all of the participation in such activity of all individuals (including individuals who are not owners of interests in the activity) for such year Participation > 100 hours and is not less than participation of any other individual (including individuals who are not owners of interests in the activity) for such year; Significant participation activity (SPA) and aggregate participation in all SPAs during year > 500 hours Prior Year MP Tests MP in any 5 prior tax years (whether or not consecutive) during prior 10 years Personal service activity and individual materially participated in the activity for any 3 prior tax years (whether or not consecutive) Facts and Circumstances Test Based on all of facts and circumstances, individual participates in the activity on a regular, continuous, and substantial basis during the yearPnPPnPPnP  #MP definitions - SPA>Trade or business activity (1.469-1T(e)(2)) in which individual significantly participates for the year Would be an activity in which individual does not materially participate for the year if material participation for the year were determined without regard to the SPA rule. MP must exceed 100 hours for the year. +ExampleJessica owns following activities and participates as follows for 2010 A  Engineering business 1,600 hours B  Rental property 120 hours C  Fast food S corp 300 hours D  Video rental S corp 350 hours Analysis: A  not SPA because another MP test met B  not SPA because not a T or B (is a rental) C and D  SPA because > 100 hours and no other MP test met (assuming prior years MP test met for neither) AND total hours in SPAs > 500 Conclusion  Jessica is MP in A, C and DtGPP PP)PG )>1$TMP Definitions  Personal Service Activity++&Involves performance of personal services in (1) fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting; or (2) any other trade or business in which capital is not a material income-producing factor. 60vY&>MP  facts & circumstances test Facts and circumstances  reserved Hours must exceed 100 Certain management activities - individual's services performed in management of an activity are ignored in determining if he is material participant for F & C test UNLESS, for the year  (A) No person (other than such individual) who performs services in connection with the management of the activity receives compensation described in section 911(d)(2)(A) in consideration for such services; and (B) No individual performs services in connection with the management of the activity that exceed (by hours) the amount of such services performed by such individual. 1.469-5T(b)Z'*MP  limited partnersN1.469-5T(e) Can be MP if meet Test 1, 5 or 6 If also holds general partner interest: Don t treat as ltd partner for MP measurement purposes, so can meet any MP test &WQWQ( MP and LLCs Garnett v. Commissioner, 132 T.C. No. 19 (2009) Generally, interest held as limited partner is passive unless provided otherwise in regs. Regs allow ltd partner to meet material participation test if also GP or can use 3 of the 7 MP tests of 1.469-5 (> 500 hours, prior MP in 5/10 years, or personal service activity and MP in any prior 3 years) 469 enacted 1986; LLPs not around until 1991 IRS  owners of LLPs and LLCs have limited liability so should be treated similar as limited partners under 469 Court noted that 469(h)(2) is not that broad  says,   interest in a limited partnership as a limited partner  so, specific to ltd partnerships Conclusions: Partners did not hold their interests in certain LLPs and LLCs as  limited partners. Therefore, not subject to rule of presumed passive activity at 469(h)(2). Also, because partners'  interests in the tenancies in common are not interests in limited partnerships, these interests also are not subject to the rule of sec. 469(h)(2) Basically, legislative purpose of 469 better served by treating the LLP and LLC members as general partners. Thus, they can apply any of the 7 MP tests. Similarly  Thompson v. U.S., 104 AFTR 2d 2009-5381, (Ct Fed Cl), acq1PZPP?PPFPZ?   ) 3'%$ 0CAOD on Thompson case$  On July 20, 2009, the Court of Federal Claims issued a summary judgment opinion in Thompson v. U.S., 87 Fed. Cl. 728 (Fed. Cl. 2009), concluding that LLC interests are not  limited partnership interests for purposes of 1.469-5T(e)(3)(i). Thompson joined Garnett v. Commissioner , 132 T.C. 19 (2009) and Gregg v. U.S., 186 F. Supp. 2d 1123 (D. Or. 2000) as the third case to rule against the position that an interest in an LLC is a limited partnership interest under 1.469-5T(e)(3)(i). The taxpayer in Thompson directly owned 99% of an LLC that was in the airplane charter business. The taxpayer indirectly owned the remaining 1% interest through a wholly-owned S corporation. The Service disallowed losses that the taxpayer claimed arguing that the taxpayer failed to meet the restricted material participation requirements that applied to limited partners under 1.469-5T(e)(3)(i). Both parties stipulated that if the taxpayer's LLC interest was not characterized for purposes of 469 as a limited partnership interest then the taxpayer could establish material participation using any of the seven tests in 1.469-5T(a). The Court in Thompson held that the taxpayer's interest was not a limited partnership interest for purposes of 469, and that even if the interest was treated as an interest in a limited partnership, the taxpayer's interest would best be categorized as a general partnership interest under 1.469-5T(e)(3)(ii). Consequently, the Court held that the taxpayer could establish material participation using any of the seven tests in 1.469-5T(a). See also, Garnett and Gregg , supra. Recommendation Acquiesce in result only. yPT s  g|f _$ 0fg$ 0$ 0$ 0$ 06#Different Tax Years & MP .1.469-2T(e)(1) Partnership has 9/30 year end Partner Tom wants to know if he meets a MP test. Q  does he look at calendar year or year ended 9/30/10?  MP RemindersMust check each year No prorating in quantitative tests for short years Participation of spouse counts  always ask what spouse does in the activity -5(f) and -5T(f): Must be work customarily done by an owner of such an activity; and One of the principal purposes for the performance of such work must not be to avoid the 469 rules Generally, work done in individual's capacity as an investor (studying financial statements, preparing financial analyses, monitoring finances or operations in a non-managerial capacity) in an activity is not counted unless the individual is directly involved in the day-to-day management or operations of the activity. .PP7$ MP QuestionJane provides legal services to partnership X as employee of law firm. Jane is also a 5% owner of X which manufacturer widgets. Q  Should Jane include her law firm hours serving X as part of her hours in determining if she is a material participant in X?) Proving MP1.469-5T(f)(4)   Methods of proof. The extent of an individual's participation in an activity may be established by any reasonable means. Contemporaneous daily time reports, logs, or similar documents are not required if the extent of such participation may be established by other reasonable means. Reasonable means for purposes of this paragraph may include but are not limited to the identification of services performed over a period of time and the approximate number of hours spent performing such services during such period, based on appointment books, calendars, or narrative summaries. Practical application? Have client keep records, particularly if close to an hour cut off point or has other full-time employmentDmZkZJk,`Q  can < 100 hours of participation ever be MP?11&fYes  substantially all test Prior years MP tests&00R,Q  are MP regs valid? Mordkin, et ux., TC Memo 1996-187 Challenged the regs as invalid because applied quantitative measures when statute implied a qualitative measure. Court upheld the reg noting it was appropriate interpretation whether viewed as an interpretive reg or a legislative reg  a review of other portions of the legislative history of section 469 confirms that the material participation test implicates the amount and extent of the time spent by a taxpayer in connection with the operations of an activity. For instance, that legislative history indicates that a taxpayer is most likely to participate materially in an activity if involvement in that activity is the taxpayer's principal business and the taxpayer devotes most of his or her time to that business and does not devote a comparable amount of time to another business (principal business factor). :#Z3Z3l$oLJQNextQuiz on Desire 2 Learn Then & Podcast going over the examples in regs on rental exceptions and material participation Powerpoint presentation on more rules in 469 including definition of  activity, measurements of PAL and PAI, recharacterization rules, and more!&P1 d/D !"%* . 0 2 8 9HIJKLMNOPQRST U!V"<=>?@ABCDEF$ D 0  $(  r  S + `}   r  S P, `  H  0޽h ? ___f3̙;/f980___PPT10.hpQ  0 `(  `r ` S   `}   r ` S   `  ^ ` C 6AMC910217022[1]H ` 0޽h ? ___f3̙;/f980___PPT10.~   0 ~(  r  S  `}   r  S l `  R  C *Aj0217436 @uH  0޽h ? ___f3̙;/f980___PPT10.Fn9~  0 p~(  r  S  `}   r  S  `  R  C *Aj0150022P`H  0޽h ? ___f3̙;/f980___PPT10.=>$   0 $(  r  S ( `}   r  S  `  H  0޽h ? ___f3̙;/f980___PPT10.l@E   0 (  r  S  `}   r  S  `  ^  C 6AMC900442036[1]H  0޽h ? ___f3̙;/f980___PPT10.>p'$ F 0  $(  r  S H `}   r  S Lˇ `  H  0޽h ? ___f3̙;/f980___PPT10.iP-  0 <4 (  r  S j `}   r  S  `  D  3 9k=< D  T  C ,Ad2l_logo pH  0޽h ? ___f3̙;/f980___PPT10.h=R 0 2* (  X  C 0(K   J*  S 0 0)  J z assuming arguendo, as petitioners contend, and respondent does not dispute, that that regulation were an interpretative, and not a legislative, regulation, we would nonetheless uphold its validity because we conclude that section 1.469-5T(a)(1), Temporary Income Tax Regs., supra, implements the congressional mandate in a reasonable manner, the standard of review for an interpretative regulation. A fortiori that regulation would not be arbitrary, capricious, or manifestly contrary to the underlying statute, the higher standard of review for a legislative regulation. . .H  0޽h ? 3380___PPT10.i5rH U16)_0Q  ( v |  hhttp://finance.senate.gov/hearings/hearing/?id=1d2a7636-5056-a032-5282-4bb7cf0d5078http://finance.senate.gov/hearings/hearing/?id=1d2a7636-5056-a032-5282-4bb7cf0d5078d/getDoc?DocID=T0TCODE:11186.1&pinpnt=TCODE:11244.1https://checkpoint.riag.com/getDoc?DocID=T0TCODE:11186.1&pinpnt=TCODE:11244.1B/getDoc?DocID=T0TCODE:7.1&pinpnt=xhttps://checkpoint.riag.com/getDoc?DocID=T0TCODE:7.1&pinpnt=/ 00DArialngsRoman8 0"DGaramondRoman8 0 DTimes New Roman8 00DWingdingsRoman8 0@0.  @n?" dd@  @@`` pT      #'()*+,-./012345689:;?@ABOPQRSTUVWXYZ[\]4b$??l9) b$.720,u!D1v2$^'uˈQmX{ZB$2$Ϝng\|+mS2$DCoh#r!G773LR$kb%0ټaH._3; 0AA3@8C ʚ;ʚ;g4jdjd 0ppp@ <4dddd&) 0 <4BdBdH* 0g4RdRd8 0(pp pp0___PPT10 ___PPT9\?  O  =AHIRC 469  Passive Activities Part 1%%iBackground, purpose, basics, relevance in the tax law, some considerations in properly applying the rulesjjN BackgroundWidespread tax shelter investments by middle to high income taxpayers in 1980s Bluebook to TRA 86 page 210  Per Treasury,  in 1983, out of 260,000 tax returns reporting  total positive income in excess of $250,000, 11% paid taxes equaling 5% or less of total positive income, and 21% paid taxes equaling 10% or less of total positive income. Similarly, in the case of tax returns reporting total positive income in excess of $1 million, 11% paid tax equaling less than 5% of total positive income, and 19% paid tax equaling less than 10% of total positive income. In 1981, top individual rate was dropped from 70% to 50%..7P:P7:Purpose of the 469 rulesPer TRA 86 Blue Book (pages 209-214) Curb expansion of tax shelters. Only allow taxpayers with substantial and bona fide involvement in certain activities to deduct losses for the activity. Other taxpayers (passive ones) can only use losses against passive activity income or upon disposition when the  true economic benefit can be determined Prevent taxpayers from offsetting wage and investment income with passive losses. Provide limited relief to moderate income taxpayers with rental real estate activities. Prevent investment capital from being diverted from productive activities to tax shelter activities.^%PPPP% 469 GuidanceIRC and legislative histories Final and temporary regulations A few rulings and court cases Forms 8582 and 8801 and instructions are also helpful, as is IRS Pub 925 (but not primary authority)GWhat does 469 do?Only allows current year use of a deduction or credit from a  passive activity to be used against passive activity income or tax on such income. Any disallowed loss or credit for the year is carried forward to the next year and subject to the same PAL and PAC limitations. It is suspended. Generally, PAL  triggered if activity disposed of in a fully taxable transaction. So  prevents use of passive activity loss against non-passive income (such as wages and investment income).XPPP OBKey to application of the rules & \Activity is  passive if: T or B in which taxpayer does not materially participate. Any rental activity. Exceptions and special rules Rental real estate with active participation and AGI < $150,000. Real estate professional (added in 1993) Important  Meaning of:  activity  trade of business  rental  material participation Tracking of income, losses and suspended losses (and credits) of passive activities. Recordkeeping.POPPjP P PCPdPOj   C  d   +Early reaction to 469 and initial guidance,,&Is somewhat complicated due to length of rules, lots of definitions and special rules, and the grouping and recordkeeping needed to determine each passive activities PAL and PAC Letter reprinted in DTR 6/30/99  letter signed by  Disgusted called the temporary regulations  boring and incomprehensible and suggested that IRS should  throw them out altogether as unworkable and unenforceable.  And more & 2Friends of Oregon, et al v. Sec. of Treasury and IRS Comm r (DC Or 1988)  brought action to require IRS to prepare environmental impact study and to obtain court approval before adopting the 469 regs. Were concerned with the MP tests. Noted that regs encourage timber owners to convert timber lands to non-timber uses to get better tax result. Court disallowed claim for lack of subject matter jurisdiction6[?; ?>50 More reactionsConcerns that the rules hurt the real estate industry, such as Price declines (which also hurt local governments due to drop in property tax collections) Some say the rules helped fuel the subsequent S&L crisis&??MEconomic consequencesTestimony of Bill Archer, now with PWC, but formerly member and chair (1995-2001) of the House Ways & Means Committee 9/23/10 SFC hearing on lessons learned from TRA 86  The 1986 Act made a significant change to real estate investments on a retroactive basis, causing serious adverse consequences. I am referring to the passive loss rules that imposed restrictions on the deduction of losses from existing real estate investments. A number of economists and the Federal Reserve have cited this change as adversely impacting real estate values, which in turn contributed to the U.S. savings and loan crisis during the late 1980's and early 1990's. http://finance.senate.gov/hearings/hearing/?id=1d2a7636-5056-a032-5282-4bb7cf0d5078 \vPgPPv42$ 0H469 is in Subchapter EAccounting method? Notice 94-49   the passive activity rules may be viewed as character rules because they limit absorption of losses, or as timing rules because the losses ultimately will be absorbed St. Charles Investment Co. v. Commissioner, 110 T.C. 46 (1998), rev d on appeal Noted that while Congress did place 469 in Subchapter E, in the legislative history, it is explained under topic of  tax shelters rather than accounting methods (such as where 448 is discussed). TAM 201035016 --- Z ZZZZ*&  ITAM 201035016 &T says was MP in partnership in 1990  1994. IRS auditing 1994 and says did not MP in 1994. Asked National Office if  a recharacterization of the taxpayers' activities from nonpassive to passive for purposes of the passive activity loss and credit limit rules of 469 was a change in a  method of accounting for purposes of 446(e) and 481(a)? [Z[ R,x# JTAM 201035016 - more> Each year the taxpayers review their facts and decide whether during that year they materially participated in their nursing home activity. If the taxpayers did not materially participate, their nursing home activity must be classified as passive under the 469 rules. Based on the facts present in one year, the activity may be nonpassive in that year, while in another year, under the facts present in that year, the activity may be passive. Under the argument advocated by the examiner, each year that the activity changed from nonpassive to passive, or vice versa, the taxpayers would be required to file a Form 3115, Application for Change in Accounting Method. In each year of change, the taxpayers would be required to compute an adjustment under 481(a). If, for example, a taxpayer materially participated in an activity in 1997, but did not in 1998, the examiner would have the taxpayer file a Form 3115 for 1998. Any amounts that were properly deducted in 1997 because the activity was nonpassive, that would have been deferred had the activity been passive would be included in the computation under 481(a). Similarly, in the instant case, the examiner believes that if the taxpayers did not materially participate in 1994, the examiner may bring into income in 1994 any amounts that were deducted in prior years, that would not have been deductible in those years if the taxpayers had not materially participated in those years. The examiner believes that this may be done, by virtue of 481(a), without regard to whether the taxpayers materially participated in the nursing home activity in the prior years. The examiner notes that this is because, if a change from determining that a taxpayer materially participated in an activity to determining that it did not materially participate in the activity is a change in method of accounting, 481(a) authorizes necessary adjustments to prevent amounts from being duplicated or omitted. P @>J   K4TAM 201035016  conclusion We do not believe that a determination of whether a taxpayer materially participates in an activity is a method of accounting. In this case, the taxpayers' determination of whether they materially participate in their nursing home activity does not determine into which period an item of income or deduction will be placed. The taxpayers' determination does not involve the treatment of a  material item. Simply, determining whether the taxpayers materially participated in their activity for purposes of classifying the activity as passive or not is not an  item  it is not a recurring incidence of income or expense. Instead, the taxpayers' determination establishes the character of their activity for that year it is either passive or it is not passive. Once the character of the activity is determined, then if the activity is passive, the taxpayers must apply the statutorily mandated rules of 469 to any existing loss. So, if improperly applied MP in 1994, that is an error.  PLTAM 201035016 - commentsOdd ruling Statute is clear that MP is an annual determination, so whether an activity is passive or not can change from year to year. What is benefit of change from non-passive to passive being a method? Better question would be: T thought it met a MP test for past 6 years, but turns out did not. If method, 481(a) adjustment would bring past improperly claimed losses back into income. Notice 94-49 and St. Charles Investment Co. v. Commissioner, 110 T.C. 46 (1998) l  * Who is subject to 469TIndividuals Estates Trusts Closely-held C corporations Personal Service Corporations What is a passive activity?Either: A trade or business in which the taxpayer does not materially participate, or A rental activity (exception for real estate professionals at 469(c)(7)).nP@Activities specifically excluded from 469 loss limitation rulesAA&Working interests in oil and gas well 469(c)(3) & (4) and 1.469-1 t/p must have unlimited liability Rental of dwelling unit subject to 280A(c)(5) limitations 469(j)(10) and 1.469(e)(5) and 1.469-2(d)(2)(xii) Activity of trading personal property 1.469-1(e)(6)  (i) In general. An activity of trading personal property for the account of owners of interests in the activity is not a passive activity (without regard to whether such activity is a trade or business activity (within the meaning of paragraph (e)(2) of this section)). (ii) Personal property. For purposes of this paragraph (e)(6), the term  personal property means personal property (within the meaning of section 1092(d), without regard to paragraph (3) thereof). &P@P;P6P6PP&@;66  D T or B versus Rental Activity1.469-4(b)  (1) Trade or business activities. Trade or business activities are activities, other than rental activities or activities that are treated under 1.469-1T(e)(3)(vi)(B) as incidental to an activity of holding property for investment, that (i) Involve the conduct of a trade or business (within the meaning of section 162); (ii) Are conducted in anticipation of the commencement of a trade or business; or (iii) Involve research or experimental expenditures that are deductible under section 174 (or would be deductible if the taxpayer adopted the method described in section 174(a)). (2) Rental activities. Rental activities are activities that constitute rental activities within the meaning of 1.469-1T(e)(3). nZ_ZZ "_n Rental Activity`Generally, per 469(j)(6) and 1.469-1T(e): Involves tangible property used by customers or held for use by customers; and The gross income generated is from  amounts paid or to be paid principally for the use of such tangible property (without regard to whether the use of the property by customers is pursuant to a lease or pursuant to a service contract or other arrangement that is not denominated a lease). 6 exceptions exist6 Rental Exceptions1.469-1T(e) and -1(e) Average period of customer use < 7 days Average period of customer use < 30 days AND significant personal services provided Average period of customer use > 30 days and extraordinary personal services provided Rental incidental to a non-rental activity Property available during defined business hours for nonexclusive use by various customers Property provided by its owner for use in an activity of a p/s, S corp or joint venture in which the owner has an interest Exceptions must be applied each year.nPP&P6'&3,[ @ Average period of customer use FOriginal definition was changed by a later reg to avoid abuse. OLD definition: Aggregate # days in all period of customer use during TY # such periods of customer use NEW: weighs difference in rental value of the activity s property causing higher rental value property to have greater effect than lower rental value property Prevents t/p from lowering a longer rental period by short-term rentals of low value propertydOX^O9^,+!RExample of formula /BExample  Residential Care CenterrTAM 9247003  retirement center owned by ltd p/s. Q  rental or T or B? Centers provided all meals, maid service, laundry, recreational activities and transportation. Rental charge exceeded 2X cost of a luxury apt due to the services provided IRS Auditor  rental activity IRS National Office  what do you think?&22- 1HEX  Construction of rental propertyT was constructing and developing what would become rental property. Q  how to characterize the construction activity? TAM 9251003Material Participation2469(h)  exists when t/p  is involved in the operations of the activity on a basis which is (A) regular, (B) continuous, and (C) substantial. Ltd p/s   Except as provided in regulations, no interest in a limited partnership as a limited partner shall be treated as an interest with respect to which a taxpayer materially participates. Married taxpayers Include participation of each spouse to determine if either participates. Can be beneficial when want to be a MP, but detrimental when trying to not be a MP Regs. 1.469-5 and -5TBfPPPf>|kMaterial Participation TestsQuantitative Tests > 500 hours Participation constitutes substantially all of the participation in such activity of all individuals (including individuals who are not owners of interests in the activity) for such year Participation > 100 hours and is not less than participation of any other individual (including individuals who are not owners of interests in the activity) for such year; Significant participation activity (SPA) and aggregate participation in all SPAs during year > 500 hours Prior Year MP Tests MP in any 5 prior tax years (whether or not consecutive) during prior 10 years Personal service activity and individual materially participated in the activity for any 3 prior tax years (whether or not consecutive) Facts and Circumstances Test Based on all of facts and circumstances, individual participates in the activity on a regular, continuous, and substantial basis during the yearPnPPnPPnP  #MP definitions - SPA>Trade or business activity (1.469-1T(e)(2)) in which individual significantly participates for the year Would be an activity in which individual does not materially participate for the year if material participation for the year were determined without regard to the SPA rule. MP must exceed 100 hours for the year. +ExampleJessica owns following activities and participates as follows for 2010 A  Engineering business 1,600 hours B  Rental property 120 hours C  Fast food S corp 300 hours D  Video rental S corp 350 hours Analysis: A  not SPA because another MP test met B  not SPA because not a T or B (is a rental) C and D  SPA because > 100 hours and no other MP test met (assuming prior years MP test met for neither) AND total hours in SPAs > 500 Conclusion  Jessica is MP in A, C and DtGPP PP)PG )>1$TMP Definitions  Personal Service Activity++&Involves performance of personal services in (1) fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting; or (2) any other trade or business in which capital is not a material income-producing factor. 60vY&>MP  facts & circumstances test Facts and circumstances  reserved Hours must exceed 100 Certain management activities - individual's services performed in management of an activity are ignored in determining if he is material participant for F & C test UNLESS, for the year  (A) No person (other than such individual) who performs services in connection with the management of the activity receives compensation described in section 911(d)(2)(A) in consideration for such services; and (B) No individual performs services in connection with the management of the activity that exceed (by hours) the amount of such services performed by such individual. 1.469-5T(b)Z'*MP  limited partnersN1.469-5T(e) Can be MP if meet Test 1, 5 or 6 If also holds general partner interest: Don t treat as ltd partner for MP measurement purposes, so can meet any MP test &WQWQ( MP and LLCs Garnett v. Commissioner, 132 T.C. No. 19 (2009) Generally, interest held as limited partner is passive unless provided otherwise in regs. Regs allow ltd partner to meet material participation test if also GP or can use 3 of the 7 MP tests of 1.469-5 (> 500 hours, prior MP in 5/10 years, or personal service activity and MP in any prior 3 years) 469 enacted 1986; LLPs not around until 1991 IRS  owners of LLPs and LLCs have limited liability so should be treated similar as limited partners under 469 Court noted that 469(h)(2) is not that broad  says,   interest in a limited partnership as a limited partner  so, specific to ltd partnerships Conclusions: Partners did not hold their interests in certain LLPs and LLCs as  limited partners. Therefore, not subject to rule of presumed passive activity at 469(h)(2). Also, because partners'  interests in the tenancies in common are not interests in limited partnerships, these interests also are not subject to the rule of sec. 469(h)(2) Basically, legislative purpose of 469 better served by treating the LLP and LLC members as general partners. Thus, they can apply any of the 7 MP tests. Similarly  Thompson v. U.S., 104 AFTR 2d 2009-5381, (Ct Fed Cl), acq1PZPP?PPFPZ?   ) 3'%$ 0CAOD on Thompson case$  On July 20, 2009, the Court of Federal Claims issued a summary judgment opinion in Thompson v. U.S., 87 Fed. Cl. 728 (Fed. Cl. 2009), concluding that LLC interests are not  limited partnership interests for purposes of 1.469-5T(e)(3)(i). Thompson joined Garnett v. Commissioner , 132 T.C. 19 (2009) and Gregg v. U.S., 186 F. Supp. 2d 1123 (D. Or. 2000) as the third case to rule against the position that an interest in an LLC is a limited partnership interest under 1.469-5T(e)(3)(i). The taxpayer in Thompson directly owned 99% of an LLC that was in the airplane charter business. The taxpayer indirectly owned the remaining 1% interest through a wholly-owned S corporation. The Service disallowed losses that the taxpayer claimed arguing that the taxpayer failed to meet the restricted material participation requirements that applied to limited partners under 1.469-5T(e)(3)(i). Both parties stipulated that if the taxpayer's LLC interest was not characterized for purposes of 469 as a limited partnership interest then the taxpayer could establish material participation using any of the seven tests in 1.469-5T(a). The Court in Thompson held that the taxpayer's interest was not a limited partnership interest for purposes of 469, and that even if the interest was treated as an interest in a limited partnership, the taxpayer's interest would best be categorized as a general partnership interest under 1.469-5T(e)(3)(ii). Consequently, the Court held that the taxpayer could establish material participation using any of the seven tests in 1.469-5T(a). See also, Garnett and Gregg , supra. Recommendation Acquiesce in result only. yPT s  g|f _$ 0fg$ 0$ 0$ 0$ 06#Different Tax Years & MP .1.469-2T(e)(1) Partnership has 9/30 year end Partner Tom wants to know if he meets a MP test. Q  does he look at calendar year or year ended 9/30/10?  MP RemindersMust check each year No prorating in quantitative tests for short years Participation of spouse counts  always ask what spouse does in the activity -5(f) and -5T(f): Must be work customarily done by an owner of such an activity; and One of the principal purposes for the performance of such work must not be to avoid the 469 rules Generally, work done in individual's capacity as an investor (studying financial statements, preparing financial analyses, monitoring finances or operations in a non-managerial capacity) in an activity is not counted unless the individual is directly involved in the day-to-day management or operations of the activity. .PP7$ MP QuestionJane provides legal services to partnership X as employee of law firm. Jane is also a 5% owner of X which manufacturer widgets. Q  Should Jane include her law firm hours serving X as part of her hours in determining if she is a material participant in X?) Proving MP1.469-5T(f)(4)   Methods of proof. The extent of an individual's participation in an activity may be established by any reasonable means. Contemporaneous daily time reports, logs, or similar documents are not required if the extent of such participation may be established by other reasonable means. Reasonable means for purposes of this paragraph may include but are not limited to the identification of services performed over a period of time and the approximate number of hours spent performing such services during such period, based on appointment books, calendars, or narrative summaries. Practical application? Have client keep records, particularly if close to an hour cut off point or has other full-time employmentDmZkZJk,`Q  can < 100 hours of participation ever be MP?11&fYes  substantially all test Prior years MP tests&00R,Q  are MP regs valid? Mordkin, et ux., TC Memo 1996-187 Challenged the regs as invalid because applied quantitative measures when statute implied a qualitative measure. Court upheld the reg noting it was appropriate interpretation whether viewed as an interpretive reg or a legislative reg  a review of other portions of the legislative history of section 469 confirms that the material participation test implicates the amount and extent of the time spent by a taxpayer in connection with the operations of an activity. For instance, that legislative history indicates that a taxpayer is most likely to participate materially in an activity if involvement in that activity is the taxpayer's principal business and the taxpayer devotes most of his or her time to that business and does not devote a comparable amount of time to another business (principal business factor). :#Z3Z3l$oLJQNextQuiz on Desire 2 Learn Then & Podcast going over the examples in regs on rental exceptions and material participation Powerpoint presentation on more rules in 469 including definition of  activity, measurements of PAL and PAI, recharacterization rules, and more!&P1 d/D !"%* . 0 2 8 9HIJKLMNOPQRST U!V"<=>?@ABCDEFrQ  ( v | hhttp://finance.senate.gov/hearings/hearing/?id=1d2a7636-5056-a032-5282-4bb7cf0d5078http://finance.senate.gov/hearings/hearing/?id=1d2a7636-5056-a032-5282-4bb7cf0d5078/ 00DArialngsRoman4/ 0DGaramondRoman4/ 0 DTimes New Roman4/ 00DWingdingsRoman4/ 0@0.  @n?" dd@  @@`` pT      #'()*+,-./012345689:;?@ABOPQRSTUVWXYZ[\]4b$??l9) b$.720,u!D1v2$^'uˈQmX{ZB$2$Ϝng\|+mS2$DCoh#r!G773LR$kb%0ټaH._3; 0AA3@8C ʚ;ʚ;g4jdjdg 0ppp@ <4dddd&) 0/ <4BdBdH* 0g4RdRdpi 0(pp pp0___PPT10 ___PPT9\?  O  =AHIRC 469  Passive Activities Part 1%%iBackground, purpose, basics, relevance in the tax law, some considerations in properly applying the rulesjjN BackgroundWidespread tax shelter investments by middle to high income taxpayers in 1980s Bluebook to TRA 86 page 210  Per Treasury,  in 1983, out of 260,000 tax returns reporting  total positive income in excess of $250,000, 11% paid taxes equaling 5% or less of total positive income, and 21% paid taxes equaling 10% or less of total positive income. Similarly, in the case of tax returns reporting total positive income in excess of $1 million, 11% paid tax equaling less than 5% of total positive income, and 19% paid tax equaling less than 10% of total positive income. In 1981, top individual rate was dropped from 70% to 50%..7P:P7:Purpose of the 469 rulesPer TRA 86 Blue Book (pages 209-214) Curb expansion of tax shelters. Only allow taxpayers with substantial and bona fide involvement in certain activities to deduct losses for the activity. Other taxpayers (passive ones) can only use losses against passive activity income or upon disposition when the  true economic benefit can be determined Prevent taxpayers from offsetting wage and investment income with passive losses. Provide limited relief to moderate income taxpayers with rental real estate activities. Prevent investment capital from being diverted from productive activities to tax shelter activities.^%PPPP% 469 GuidanceIRC and legislative histories Final and temporary regulations A few rulings and court cases Forms 8582 and 8801 and instructions are also helpful, as is IRS Pub 925 (but not primary authority)GWhat does 469 do?Only allows current year use of a deduction or credit from a  passive activity to be used against passive activity income or tax on such income. Any disallowed loss or credit for the year is carried forward to the next year and subject to the same PAL and PAC limitations. It is suspended. Generally, PAL  triggered if activity disposed of in a fully taxable transaction. So  prevents use of passive activity loss against non-passive income (such as wages and investment income).XPPP OBKey to application of the rules & \Activity is  passive if: T or B in which taxpayer does not materially participate. Any rental activity. Exceptions and special rules Rental real estate with active participation and AGI < $150,000. Real estate professional (added in 1993) Important  Meaning of:  activity  trade of business  rental  material participation Tracking of income, losses and suspended losses (and credits) of passive activities. Recordkeeping.POPPjP P PCPdPOj   C  d   +Early reaction to 469 and initial guidance,,&Is somewhat complicated due to length of rules, lots of definitions and special rules, and the grouping and recordkeeping needed to determine each passive activities PAL and PAC Letter reprinted in DTR 6/30/99  letter signed by  Disgusted called the temporary regulations  boring and incomprehensible and suggested that IRS should  throw them out altogether as unworkable and unenforceable.  And more & 2Friends of Oregon, et al v. Sec. of Treasury and IRS Comm r (DC Or 1988)  brought action to require IRS to prepare environmental impact study and to obtain court approval before adopting the 469 regs. Were concerned with the MP tests. Noted that regs encourage timber owners to convert timber lands to non-timber uses to get better tax result. Court disallowed claim for lack of subject matter jurisdiction6[?; ?>50 More reactionsConcerns that the rules hurt the real estate industry, such as Price declines (which also hurt local governments due to drop in property tax collections) Some say the rules helped fuel the subsequent S&L crisis&??MEconomic consequencesTestimony of Bill Archer, now with PWC, but formerly member and chair (1995-2001) of the House Ways & Means Committee 9/23/10 SFC hearing on lessons learned from TRA 86  The 1986 Act made a significant change to real estate investments on a retroactive basis, causing serious adverse consequences. I am referring to the passive loss rules that imposed restrictions on the deduction of losses from existing real estate investments. A number of economists and the Federal Reserve have cited this change as adversely impacting real estate values, which in turn contributed to the U.S. savings and loan crisis during the late 1980's and early 1990's. http://finance.senate.gov/hearings/hearing/?id=1d2a7636-5056-a032-5282-4bb7cf0d5078 \vPgPPv42$ 0H469 is in Subchapter EAccounting method? Notice 94-49   the passive activity rules may be viewed as character rules because they limit absorption of losses, or as timing rules because the losses ultimately will be absorbed St. Charles Investment Co. v. Commissioner, 110 T.C. 46 (1998), rev d on appeal Noted that while Congress did place 469 in Subchapter E, in the legislative history, it is explained under topic of  tax shelters rather than accounting methods (such as where 448 is discussed). TAM 201035016 --- Z ZZZZ*&  ITAM 201035016 &T says was MP in partnership in 1990  1994. IRS auditing 1994 and says did not MP in 1994. Asked National Office if  a recharacterization of the taxpayers' activities from nonpassive to passive for purposes of the passive activity loss and credit limit rules of 469 was a change in a  method of accounting for purposes of 446(e) and 481(a)? [Z[ R,x# JTAM 201035016 - more> Each year the taxpayers review their facts and decide whether during that year they materially participated in their nursing home activity. If the taxpayers did not materially participate, their nursing home activity must be classified as passive under the 469 rules. Based on the facts present in one year, the activity may be nonpassive in that year, while       !"#$%&'()*+,-./0123456789:;<=>?@ABCDEFGHIJKLMNOPQRSTin another year, under the facts present in that year, the activity may be passive. Under the argument advocated by the examiner, each year that the activity changed from nonpassive to passive, or vice versa, the taxpayers would be required to file a Form 3115, Application for Change in Accounting Method. In each year of change, the taxpayers would be required to compute an adjustment under 481(a). If, for example, a taxpayer materially participated in an activity in 1997, but did not in 1998, the examiner would have the taxpayer file a Form 3115 for 1998. Any amounts that were properly deducted in 1997 because the activity was nonpassive, that would have been deferred had the activity been passive would be included in the computation under 481(a). Similarly, in the instant case, the examiner believes that if the taxpayers did not materially participate in 1994, the examiner may bring into income in 1994 any amounts that were deducted in prior years, that would not have been deductible in those years if the taxpayers had not materially participated in those years. The examiner believes that this may be done, by virtue of 481(a), without regard to whether the taxpayers materially participated in the nursing home activity in the prior years. The examiner notes that this is because, if a change from determining that a taxpayer materially participated in an activity to determining that it did not materially participate in the activity is a change in method of accounting, 481(a) authorizes necessary adjustments to prevent amounts from being duplicated or omitted. P @>J   K4TAM 201035016  conclusion We do not believe that a determination of whether a taxpayer materially participates in an activity is a method of accounting. In this case, the taxpayers' determination of whether they materially participate in their nursing home activity does not determine into which period an item of income or deduction will be placed. The taxpayers' determination does not involve the treatment of a  material item. Simply, determining whether the taxpayers materially participated in their activity for purposes of classifying the activity as passive or not is not an  item  it is not a recurring incidence of income or expense. Instead, the taxpayers' determination establishes the character of their activity for that year it is either passive or it is not passive. Once the character of the activity is determined, then if the activity is passive, the taxpayers must apply the statutorily mandated rules of 469 to any existing loss. So, if improperly applied MP in 1994, that is an error.  PLTAM 201035016 - commentsOdd ruling Statute is clear that MP is an annual determination, so whether an activity is passive or not can change from year to year. What is benefit of change from non-passive to passive being a method? Better question would be: T thought it met a MP test for past 6 years, but turns out did not. If method, 481(a) adjustment would bring past improperly claimed losses back into income. Notice 94-49 and St. Charles Investment Co. v. Commissioner, 110 T.C. 46 (1998) l  * Who is subject to 469TIndividuals Estates Trusts Closely-held C corporations Personal Service Corporations What is a passive activity?Either: A trade or business in which the taxpayer does not materially participate, or A rental activity (exception for real estate professionals at 469(c)(7)).nP@Activities specifically excluded from 469 loss limitation rulesAA&Working interests in oil and gas well 469(c)(3) & (4) and 1.469-1 t/p must have unlimited liability Rental of dwelling unit subject to 280A(c)(5) limitations 469(j)(10) and 1.469(e)(5) and 1.469-2(d)(2)(xii) Activity of trading personal property 1.469-1(e)(6)  (i) In general. An activity of trading personal property for the account of owners of interests in the activity is not a passive activity (without regard to whether such activity is a trade or business activity (within the meaning of paragraph (e)(2) of this section)). (ii) Personal property. For purposes of this paragraph (e)(6), the term  personal property means personal property (within the meaning of section 1092(d), without regard to paragraph (3) thereof). &P@P;P6P6PP&@;66  D T or B versus Rental Activity1.469-4(b)  (1) Trade or business activities. Trade or business activities are activities, other than rental activities or activities that are treated under 1.469-1T(e)(3)(vi)(B) as incidental to an activity of holding property for investment, that (i) Involve the conduct of a trade or business (within the meaning of section 162); (ii) Are conducted in anticipation of the commencement of a trade or business; or (iii) Involve research or experimental expenditures that are deductible under section 174 (or would be deductible if the taxpayer adopted the method described in section 174(a)). (2) Rental activities. Rental activities are activities that constitute rental activities within the meaning of 1.469-1T(e)(3). nZ_ZZ "_n Rental Activity`Generally, per 469(j)(6) and 1.469-1T(e): Involves tangible property used by customers or held for use by customers; and The gross income generated is from  amounts paid or to be paid principally for the use of such tangible property (without regard to whether the use of the property by customers is pursuant to a lease or pursuant to a service contract or other arrangement that is not denominated a lease). 6 exceptions exist6 Rental Exceptions1.469-1T(e) and -1(e) Average period of customer use < 7 days Average period of customer use < 30 days AND significant personal services provided Average period of customer use > 30 days and extraordinary personal services provided Rental incidental to a non-rental activity Property available during defined business hours for nonexclusive use by various customers Property provided by its owner for use in an activity of a p/s, S corp or joint venture in which the owner has an interest Exceptions must be applied each year.nPP&P6'&3,[ @ Average period of customer use FOriginal definition was changed by a later reg to avoid abuse. OLD definition: Aggregate # days in all period of customer use during TY # such periods of customer use NEW: weighs difference in rental value of the activity s property causing higher rental value property to have greater effect than lower rental value property Prevents t/p from lowering a longer rental period by short-term rentals of low value propertydOX^O9^,+!RExample of formula /BExample  Residential Care CenterrTAM 9247003  retirement center owned by ltd p/s. Q  rental or T or B? Centers provided all meals, maid service, laundry, recreational activities and transportation. Rental charge exceeded 2X cost of a luxury apt due to the services provided IRS Auditor  rental activity IRS National Office  what do you think?&22- 1HEX  Construction of rental propertyT was constructing and developing what would become rental property. Q  how to characterize the construction activity? TAM 9251003Material Participation2469(h)  exists when t/p  is involved in the operations of the activity on a basis which is (A) regular, (B) continuous, and (C) substantial. Ltd p/s   Except as provided in regulations, no interest in a limited partnership as a limited partner shall be treated as an interest with respect to which a taxpayer materially participates. Married taxpayers Include participation of each spouse to determine if either participates. Can be beneficial when want to be a MP, but detrimental when trying to not be a MP Regs. 1.469-5 and -5TBfPPPf>|kMaterial Participation TestsQuantitative Tests > 500 hours Participation constitutes substantially all of the participation in such activity of all individuals (including individuals who are not owners of interests in the activity) for such year Participation > 100 hours and is not less than participation of any other individual (including individuals who are not owners of interests in the activity) for such year; Significant participation activity (SPA) and aggregate participation in all SPAs during year > 500 hours Prior Year MP Tests MP in any 5 prior tax years (whether or not consecutive) during prior 10 years Personal service activity and individual materially participated in the activity for any 3 prior tax years (whether or not consecutive) Facts and Circumstances Test Based on all of facts and circumstances, individual participates in the activity on a regular, continuous, and substantial basis during the yearPnPPnPPnP  #MP definitions - SPA>Trade or business activity (1.469-1T(e)(2)) in which individual significantly participates for the year Would be an activity in which individual does not materially participate for the year if material participation for the year were determined without regard to the SPA rule. MP must exceed 100 hours for the year. +ExampleJessica owns following activities and participates as follows for 2010 A  Engineering business 1,600 hours B  Rental property 120 hours C  Fast food S corp 300 hours D  Video rental S corp 350 hours Analysis: A  not SPA because another MP test met B  not SPA because not a T or B (is a rental) C and D  SPA because > 100 hours and no other MP test met (assuming prior years MP test met for neither) AND total hours in SPAs > 500 Conclusion  Jessica is MP in A, C and DtGPP PP)PG )>1$TMP Definitions  Personal Service Activity++&Involves performance of personal services in (1) fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting; or (2) any other trade or business in which capital is not a material income-producing factor. 60vY&>MP  facts & circumstances test Facts and circumstances  reserved Hours must exceed 100 Certain management activities - individual's services performed in management of an activity are ignored in determining if he is material participant for F & C test UNLESS, for the year  (A) No person (other than such individual) who performs services in connection with the management of the activity receives compensation described in section 911(d)(2)(A) in consideration for such services; and (B) No individual performs services in connection with the management of the activity that exceed (by hours) the amount of such services performed by such individual. 1.469-5T(b)Z'*MP  limited partnersN1.469-5T(e) Can be MP if meet Test 1, 5 or 6 If also holds general partner interest: Don t treat as ltd partner for MP measurement purposes, so can meet any MP test &WQWQ( MP and LLCs Garnett v. Commissioner, 132 T.C. No. 19 (2009) Generally, interest held as limited partner is passive unless provided otherwise in regs. Regs allow ltd partner to meet material participation test if also GP or can use 3 of the 7 MP tests of 1.469-5 (> 500 hours, prior MP in 5/10 years, or personal service activity and MP in any prior 3 years) 469 enacted 1986; LLPs not around until 1991 IRS  owners of LLPs and LLCs have limited liability so should be treated similar as limited partners under 469 Court noted that 469(h)(2) is not that broad  says,   interest in a limited partnership as a limited partner  so, specific to ltd partnerships Conclusions: Partners did not hold their interests in certain LLPs and LLCs as  limited partners. Therefore, not subject to rule of presumed passive activity at 469(h)(2). Also, because partners'  interests in the tenancies in common are not interests in limited partnerships, these interests also are not subject to the rule of sec. 469(h)(2) Basically, legislative purpose of 469 better served by treating the LLP and LLC members as general partners. Thus, they can apply any of the 7 MP tests. Similarly  Thompson v. U.S., 104 AFTR 2d 2009-5381, (Ct Fed Cl), acq1PZPP?PPFPZ?   ) 3'%$ 0CAOD on Thompson case$  On July 20, 2009, the Court of Federal Claims issued a summary judgment opinion in Thompson v. U.S., 87 Fed. Cl. 728 (Fed. Cl. 2009), concluding that LLC interests are not  limited partnership interests for purposes of 1.469-5T(e)(3)(i). Thompson joined Garnett v. Commissioner , 132 T.C. 19 (2009) and Gregg v. U.S., 186 F. Supp. 2d 1123 (D. Or. 2000) as the third case to rule against the position that an interest in an LLC is a limited partnership interest under 1.469-5T(e)(3)(i). The taxpayer in Thompson directly owned 99% of an LLC that was in the airplane charter business. The taxpayer indirectly owned the remaining 1% interest through a wholly-owned S corporation. The Service disallowed losses that the taxpayer claimed arguing that the taxpayer failed to meet the restricted material participation requirements that applied to limited partners under 1.469-5T(e)(3)(i). Both parties stipulated that if the taxpayer's LLC interest was not characterized for purposes of 469 as a limited partnership interest then the taxpayer could establish material participation using any of the seven tests in 1.469-5T(a). The Court in Thompson held that the taxpayer's interest was not a limited partnership interest for purposes of 469, and that even if the interest was treated as an interest in a limited partnership, the taxpayer's interest would best be categorized as a general partnership interest under 1.469-5T(e)(3)(ii). Consequently, the Court held that the taxpayer could establish material participation using any of the seven tests in 1.469-5T(a). See also, Garnett and Gregg , supra. Recommendation Acquiesce in result only. yPT s  g|f _$ 0fg$ 0$ 0$ 0$ 06#Different Tax Years & MP .1.469-2T(e)(1) Partnership has 9/30 year end Partner Tom wants to know if he meets a MP test. Q  does he look at calendar year or year ended 9/30/10?  MP RemindersMust check each year No prorating in quantitative tests for short years Participation of spouse counts  always ask what spouse does in the activity -5(f) and -5T(f): Must be work customarily done by an owner of such an activity; and One of the principal purposes for the performance of such work must not be to avoid the 469 rules Generally, work done in individual's capacity as an investor (studying financial statements, preparing financial analyses, monitoring finances or operations in a non-managerial capacity) in an activity is not counted unless the individual is directly involved in the day-to-day management or operations of the activity. .PP7$ MP QuestionJane provides legal services to partnership X as employee of law firm. Jane is also a 5% owner of X which manufacturer widgets. Q  Should Jane include her law firm hours serving X as part of her hours in determining if she is a material participant in X?) Proving MP1.469-5T(f)(4)   Methods of proof. The extent of an individual's participation in an activity may be established by any reasonable means. Contemporaneous daily time reports, logs, or similar documents are not required if the extent of such participation may be established by other reasonable means. Reasonable means for purposes of this paragraph may include but are not limited to the identification of services performed over a period of time and the approximate number of hours spent performing such services during such period, based on appointment books, calendars, or narrative summaries. Practical application? Have client keep records, particularly if close to an hour cut off point or has other full-time employmentDmZkZJk,`Q  can < 100 hours of participation ever be MP?11&fYes  substantially all test Prior years MP tests&00R,Q  are MP regs valid? Mordkin, et ux., TC Memo 1996-187 Challenged the regs as invalid because applied quantitative measures when statute implied a qualitative measure. Court upheld the reg noting it was appropriate interpretation whether viewed as an interpretive reg or a legislative reg  a review of other portions of the legislative history of section 469 confirms that the material participation test implicates the amount and extent of the time spent by a taxpayer in connection with the operations of an activity. 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