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IRC §469 – Passive Activities

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					IRC §469 – Passive Activities
          Part 4

    Definition of “activity,” rental real estate
     with active participation, real estate
     professionals, interaction with other
                       rules


                                                   1
Activity -4

Definition of “activity” relevant for:
 Classifying activity – rental or T or B (or
  something else)
 Did taxpayer materially participate?

 Did taxpayer dispose of the activity?




                                                2
Congress’ concerns with defining
“activity”
   Blue Book TRA/86 page 245




                                   3
Congress’ suggestion on defining
“activity”
   Look at what is a separate activity per a “realistic economic
    sense”
   “What undertakings consist of an integrated and inter-related
    economic unit, conducted in coordination with or reliance upon
    each other, and constituting an appropriate unit for the
    measurement of gain or loss”
   Analogy to hobby loss rules of §183 is appropriate.
   “The fact that two undertakings are conducted by the same entity
    (such as a partnership or S corporation) does not establish that
    they are part of the same activity. Conversely, the fact that two
    undertakings are conducted by different entities does not
    establish that they are different activities. Rather, the activity
    rules generally are applied by disregarding the scope of
    passthroughentities such as partnership and S corporations.”
    (pg. 247)


                                                                     4
IRS guidance
   TD 8175 regs (1988) – did not define “activity”
   TD 8253 (1989) – included -4 on “activity”
     “4T(f)(4)(i) of the regulations provides that two trade or business
      undertakings are similar for purposes of section 1.469-4T(f) if and
      only if (A) there are predominant operations in each such
      undertaking, and (B) the predominant operations of both
      undertakings are in the same line of business. For purposes of
      this rule, there are predominant operations in an undertaking if
      more than 50 percent of the undertaking's gross income is
      attributable to operations in a single line of business.”
     Rev. Proc. 89-38 – listed the lines of business

   Replaced by TD 8565 (1994), amended by TD 8645 (1995)
     Generally simpler than temporary regs.




                                                                        5
“Activity” guidance (§1.469-4)

   Identify “appropriate economic unit” – 1 or
    more business or rental activities can be
    treated as single activity if constitute an
    appropriate economic unit for the
    measurement of gain or loss for purposes of
    section 469”
   AEU – depends on facts and circumstances
   Can use “any reasonable method of applying
    the relevant facts and circumstances in
    grouping activities”
                                                  6
Relevant facts and circumstances

i.     Similarities and differences in types of
       trades or businesses
ii.    Extent of common control
iii.   Extent of common ownership
iv.    Geographical location
v.     Interdependencies between or among the
       activities


                                                  7
Caveats

   Can’t group rental with T or B
       Unless one is insubstantial to the other
           EX – owner of apartment building has a news stand
            outside that is open every morning
   Can’t group personal property rentals with
    real property rentals
   Can’t group activities of limited partners with
    other activities


                                                                8
Example from regs

   T owns:
       Bakery and movie theater in Baltimore
       Bakery and movie theater in Philadelphia
   Question – what are possible activity
    groupings?




                                                   9
Activity grouping documentation

   Generally must stick with original grouping
       If think need to regroup – see Rev. Proc. 2010-13
   Be sure have documentation as to what is
    grouped and why.
   IRS may regroup to prevent avoidance of the
    rules
   Groupings for real estate professionals
       See 1.469-9 (per 1.469-4(h) and RP 2010-13, §3


                                                            10
§469 grouping guidance
   Rev. Proc. 2010-13
       Follow up to Notice 2008-64.
       Statement required to be filed with original return to describe:
           New groupings of passive activities
           Adding new activity to existing group
           Regroupings of passive activities + why
       P/S and S corps – follow instructions on Forms 1065 or 1120S instead.
       Failure to report – treat activities as separate
           Relief: “timely disclosure shall be deemed made by a taxpayer who has filed all affected income
            tax returns consistent with the claimed grouping of activities and makes the required disclosure
            on the income tax return for the year in which the failure to disclose is first discovered by the
            taxpayer.”
           “If the failure to disclose is first discovered by the Service, however, the taxpayer must also have
            reasonable cause for not making the disclosures required by this revenue procedure.”
       No §9100 relief available.
       IRS still has ability to regroup to prevent tax avoidance, including in situations where failure to
        disclose would otherwise result in separate activities (§1.469-4(f)).
       Effective for tax years beginning on or after January 25, 2010 .




                                                                                                               11
Example

   In current year, AB Partnership was formed.
    It owns 3 apartment buildings in the Bay
    Area. A general partner manages all three.
    Partner A also owns an apartment building on
    his own.
   Q – how many activities?
   Q – who does the grouping?



                                               12
Rental real estate w/ active participation

   §469(i)
   Rationale – “Congress believed that a limited
    measure of relief, however, was appropriate
    in the case of certain moderate-income
    investors in rental real estate, who otherwise
    might experience cash flow difficulties with
    respect to investments that in may cases
    were designed to provide financial security,
    rather than to shelter a substantial amount of
    other income.” (Blue Book, page 214)

                                                     13
§469(i) – RRE with active participation

   If applies, allows up to $25,000 offset for RRE with AP
     So could use that loss against any type of income.

   Taxpayer must own at least 10% by value of the activity
   Active participation is lesser standard than MP
   Unless future regs provide an exception, a ltd partner can’t be an
    active participant
   Benefit phases out for taxpayers with MAGI between $100,000
    and $150,000
   Only applies to individuals and certain estates.
   In measuring PAL for year, need to group RRE-AP together
    (-1T(f)(2)(iii)). Also see Form 8582 and instructions.




                                                                     14
Active participation per Congress

   Blue Book page 244




                                    15
Real Estate Professional §469(c)(7)
   Added by RRA’93
   Reg. §1.469-9
   Benefit?
       For eligible taxpayer, rental real estate (such as an
        apartment building) is not automatically passive
   RRE can’t be grouped with T or B
   Several cases
       Many involve whether taxpayer met the MP rule
           May not have if did not properly elect to group RRE such as to
            make it easier to meet MP
           Important to also have good records on MP

                                                                         16
Passive Activity Losses – Audit Technique
Guide (2/05)




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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?

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469(c)(7) - "on call" time - Moss, 135 TC
No.18 (2010)
    H worked full time at power plant
    Owned 4 rental properties in NJ and Delaware
    H handled maintenance, tenant relations, rent collection.
    Kept record of when he visited, but not of how much time
     spent. H prepared a summary in 2009 (apparently for
     auditor)
    2007 – claimed Schedule E loss of $40,490.
        IRS disallowed $31,318, allowing deductible loss of $9,172 by
         applying §469(i) rental real estate with active participation rule
         and considering that Moss income > $100,000.



                                                                          30
Moss - more

    T argued he spent total of 645.5 hours + was “on call” other
     times to get him past the 750 hour requirement to be a “real
     estate professional.”
    IRS did not raise argument that T failed to elect to treat
     rentals as one activity.
    Court - “on call” time is not actual time spent and cannot
     count towards the 750+ requirement.
    IRS determination upheld including assessment of
     accuracy related penalty.
        T unable to show reasonable cause. T did not rely on his CPA
         because he did not provide all relevant info to CPA.
        T argument that IRS mistreated them is not relevant.

                                                                    31
How §469 interacts with
other selected rules




                          32
Label versus character

Example
 Jane has
       In current tax year, has $40,000 capital gain from sale of
        passive activity.
       Has $60,000 capital loss carryforward from prior years.
       Has $70,000 PAL carryforward from prior years.
   The $40,000 gain enables Jane to use:
       $40,000 PAL
       $40,000 capital loss
       This is NOT double dipping. This the result because of two
        rules at work here – capital loss limitation rule and §469.

                                                                     33
Ordering of loss limitation rules

   -2T(d)(6) and -1(d)(2)
   Ordering of loss limitation rules:
    1.   Basis - §704(d) or §1366(d)
    2.   At risk - §465
    3.   Passive activity - §469
    4.   Capital loss limitation - §1211




                                           34
Ordering of losses - EX
   §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.




                                                                                        35
Example – loss ordering, recordkeeping
and planning
   Tom invested $50 in Partnership P that owns an apartment
    building.
   Tom’s current year loss is $70 and is a PAL.
   In subsequent year, Tom contributes $30 to the partnership. His
    PAL for that year is $10 + Y1 amount.
   Treatment of Tom’s losses:
     Y1 - $50 usable under §704(d) and $20 carries forward until he
       has enough p/s basis.
           Assuming he has at least $50 at risk amount, next get to §469
            limitation. He has no PAI so the $50 becomes a suspended PAL.
       Y2 – basis in p/s increases $30 so the Y1 $20 loss becomes
        usable and assume he also has $30 more at-risk amount. So
        now, is stuck at the §469 limitation. Has PAL of $100 (Y1 + Y2)*
           * error caught on lecture/video, should be PAL of $80


                                                                            36
Example - continued

   Recordkeeping
       Need to label losses as to why it is carried forward (under
        what loss limitation so know how to use it in future)
   Planning – referring back to example with Tom
       If is not rental activity and Tom participates in Y2, would
        cause the losses to be allowed (no §469 hurdle). Does not
        matter that he did not MP in Y1 since $20 of the Y1 loss
        never got to §469 until Y2 when he had more p/s basis.
        Also, if MP in Y2, the $10 loss from Y2 is not PAL and
        neither is the $20 because once it gets past p/s basis limit
        in Y2, Tom MPs in that year.
       The $50 that carried forward from Y1 as limited under §469
        is usable in Y2 against income from the same activity in Y2
        when Tom MPs; per §469(f) on former passive activities.


                                                                      37
f&c material participation and §1402
§1.469-5T(b) Facts and circumstances.
    (2) Certain participation insufficient to constitute material
   participation under this paragraph (b).
   (i) Participation satisfying standards not contained in section
   469. Except as provided in section 469(h)(3) and paragraph
   (h)(2) of this section (relating to certain retired individuals and
   surviving spouses in the case of farming activities), the fact that
   an individual satisfies the requirements of any participation
   standard (whether or not referred to as “material participation”)
   under any provision (including sections 1402* and 2032A and the
   regulations thereunder) other than section 469 and the
   regulations thereunder shall not be taken into account in
   determining whether such individual materially participates in any
   activity for any taxable year for purposes of section 469 and the
   regulations thereunder.
 * self-employment tax



                                                                     38
§469 and SE tax

   §1.469-1T(d)(3)
       Suspended (currently unusable) PAL can’t reduce
        taxpayer’s income taxes or self-employment
        taxes.




                                                      39
§469 and §1411 Medicare tax on unearned
income (eff. 2013)
   §1441(c)(1) and (2) – net investment income
    includes:
       Gross income from rents
       Other gross income derived from a passive
        activity (within the meaning of §469)
       Gains from property dispositions other than used
        in a T or B
       Less – “the deductions allowed by this subtitle
        which are properly allocable to such gross income
        or net gain”
                                                        40
469 and other rules

   AMT
       1987 – 1990 phase-in rules did not apply for AMT
        (so will have different PAL)
       Compute PAL and PAI using AMT preference and
        adjustment items
   Casualty losses per §165(h)
       -2(d)(2)(xi) – certain casualty and theft losses are
        NOT PADs
       Notice 90-21 – coordination of §§469, 165 and
        280B

                                                               41
§469 and NOLs

   NOLs
       Blue Book pg 222
       Prior year suspended PALs are used against
        current year PAI before NOL carryovers




                                                     42
§469 and installment sales

   Per Blue Book TRA’86 (pg 226) – “An
    installment sale of the taxpayer’s entire
    interest in an activity in a fully taxable
    transaction triggers the allowance of
    suspended losses. The losses are allowed in
    the ratio that the gain recognized in each
    year bears to the total gain on the sale.”
       Also see §469(g)(3).



                                                  43
§469 and death

   Blue Book TRA’86 (pg 226) –
       Transfer of passive activity due to death of owner
        results in suspended PAL to be allowed to extent
        it exceeds amount by which the basis of the
        interest in the activity is increased at death under
        §1014.
       Suspended PAL is eliminated to extent of basis
        step-up. [arguably, used against that “built-in” gain
        at date of death;” decedent uses excess over
        amount equal to step up at death]
       Also see §469(g)(2).

                                                            44
469 and cancellation of debt income

   COD Income
       Rev Rul 92-92 – is PAGI if debt is PA
   CODI Exclusion of §108
       List of tax attributes at 108(b) which must be
        reduced for excluded COD income includes PAL
        and PAC




                                                         45
469 and bankruptcy

   §1398 and regs at §1.1398-1
       Chapter 7 or 11 – suspended PAL and PAC
           Pass from debtor to bankruptcy estate




                                                    46
Residence rentals - §280A or §469

   Amy rents out her Lake Tahoe cabin for 50
    days in 2009 and uses it personally for 15
    days. What rule applies to her loss?
     A.   Section 469 because it is a rental
     B.   Section 280A because it meets the “use as a residence”
          test
     C.   None of the above if the average rental period is 7 days
          or less
     D.   None of the above



                                                                 47
Rental residence case - facts
Charles M. Akers, Jr., TC Memo 2010-85
 2004 – T was sole owner of 3 cabin in CS
 Schedule E expenses of about $20K which IRS disallowed
 T hired Alpine, property mgmt company to rent the cabin in 2004

       A to earn 35% commission on all rental income received
       A handled housekeeping and linens
       T maintained the property, paid utilities and “deep cleaned”
        the cabin 2x per year
   2004 - cabin rented 3x for total of 12 days and 9 nights.
       T and IRS agree that average period of tenant use in 2004
        was 3 days
   2004 – T and family visited cabin 8x (27 days and 19 nights)
       T claimed these days were to perform repairs, but had no
        proof.

                                                                    48
Holding

   §469(i)(8) and regs
       With avg period of use of 3 days, is not a rental
         Thus, no §469(i) $25,000 loss offset
         Also, it trade or business, needs to prove material
          participation to have non-passive loss. T had no records
          to prove that he met any of the 7 MP tests.
   §280A(c)(5) and (g)
       Dwelling unit is used as a residence if taxpayer’s personal
        use exceeds greater of 14 days or 10% of the fair rental
        days.
       Since rented for less than 15 days, §280A(g) applies and
        no income to be reported, but also no expenses can be
        claimed other than those that go to Schedule A


                                                                      49
Flowchart – rental of residence




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