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IRC §469 – Passive Activities

Part 5 (last one) Review + passive activity flowchart Reporting PALs and related recordkeeping Cautions in dealing with §469

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Agenda

Review – who is subject to §469? Review – what is a passive activity? Review – preparing Form 8582 Reminders and cautions in dealing with the

passive activity loss limitation and related rules

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Who is subject to §469?

§469(a)(2) (A) any individual, estate, or trust, (B) any closely held C corporation, and (C) any personal service corporation.

Also partnerships and S corporations: Need to identify and possibly group activities

§1.469-4(d)(5) and (e)(3) Provide information to owners upon disposition of ownership in

passthrough entity §1.469-2T(c)(2)

Special rules for partners and S corporation shareholders §1.469-2T(e)

Election to not apply self-charged interest rule §1.469-7(g)

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Closely-held corporation (CHC) and §469 “(j)(1) Closely held C corporation. The term “closely held C

corporation” means any C corporation described in section 465(a)(1)(B)” C corp Stock owned directly or indirectly by or for 5 or fewer individuals At any time during last half of year Such individuals own greater than 50% by value of the stock.

And per §1.469-1T(g)(2) is not a PSC. So if C corp meets both definitions, is a PSC for §469 purposes. Warning: PSC defined various ways throughout IRC – ck

applicable definition anytime you see reference to PSC in IRC.

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Personal service corporation (PSC) and §469 “(j) (2) Personal service corporation. The term “personal service

corporation” has the meaning given such term by section 269A(b)(1) , except that section 269A(b)(2) shall be applied— (A) by substituting “any” for “more than 10 percent”, and (B) by substituting “any” for “50 percent or more in value” in

section 318(a)(2)(C) . A corporation shall not be treated as a personal service

corporation unless more than 10 percent of the stock (by value) in such corporation is held by employee-owners (within the meaning of section 269A(b)(2) , as modified by the preceding sentence).”

§1.469-1T(g)(2)(i) – “The term “personal service corporation” means a C corporation that is a personal service corporation for the taxable year (within the meaning of §1.441-3(c))”

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Activity (-4)?Wage, personal

services, investment

Tangible personal property used by

customers?

No

Yes

Working interest or trading personal

property?

No

Section 469 n/a

Trade or Business per -4(b)?

YesNo

No

Is any MP test met?

Yes

Yes

Is gross income generated principally from use of tangible

property?

Yes

Does 280A(c)(5) apply?

Yes

No

Does any rental exception apply?

Passive activity

No

Yes

No

Yes

No

What is a passive activity?

Is it rental of real estate by a real

estate professional?

Yes

No

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Preparing Form 8582

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8582 - continued

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Example from Pub 925 (2009)

See pdf on 225K website for the full text of the example and forms from the IRS Publication 925 for 2009.

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Activities

Activity 2009 2008

A – RRE-AP (15,000) (6,667)

A - §1231 gain √ 2,776

B – RRE-AP (11,600) (8,225)

PS1* 4,000 (2,600)

PS2 – PTP – sold √ LTCG 15,300

¥ (1,200) ¥ (2,445)

PS3 – sold √ LTCG 4,000

¥ (6,000) ¥ (3,000)

PS4* (2,400) (1,500)

* Worksheet 3 √ Sch D ¥ Sch E

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Pub 925 – RRA-AP

Wages $132,000 PTP2 11,655 ($15,300 - $1200 - $2445) PS3 (5,000) (sold, so all PAL allowed) MAGI $138,655 Less (100,000) Excess $ 38,655 x 50% $ 19,328 Amount allowed = $25,000 - $19,328 = $5,673

Allocate this allowed PAL to each of the RRE-AP based on proportion of loss from each activity

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Pub 925 – losses reported on Form 8582 RRA-AP (38,716)* PS1 and PS4 ( 2,500) Total (41,216) Usable 469(i) ( 5,673) Suspended (35,543)**

* (15,000) + (6,667) + 2,776 + (11,600) + (8,225) ** allocate to the loss activities: A, B, PS4

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Suspended PALs

PAL from activities that are not disposed of in 2009

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Pub 925 example – Schedule E Rental loss (9,701) Partnership 1 1,400 Partnership 2 (3,645) Partnership 3 (9,000) Partnership 4 (148) Per

worksheet 6 Total (21,094)

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Pub 925 example – Schedule D Activity A $ 2,776 Partnership 2 15,300 Partnership 3 4,000 Total $22,076

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Recordkeeping

Need to track the suspended PAL per activity so can add it to the activity for the subsequent year for that activity.

Need to calculate and track amounts for AMT purposes for each activity as well.

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§469 Cautions and Reminders Rental property is a dwelling unit Rental of dwelling at less than “fair rent” Using §469(i) Recharacterization Participation reminders SPA Activity involves mostly personal services Debt §1022 and individuals who died in 2010

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Rental property is a dwelling unit §280A(d) Per §469(j)(10) and -1T(e)(5) – if the

limitations of §280A(c)(5) apply to rental of a dwelling, it is not a passive activity.

So, if personal use days of owner, including use by others at less than fair rental and use by relatives, is more than the greater of 14 days of 10% of the rental days, any loss will be limited under §280A(c)(5), not §469. And if income is generated, it is not PAI.

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Rental of dwelling at less than “fair rent” Causes such rental days to be considered

personal use by owner So more likely for owner to meet use as a

residence test of §280A(d)(1) and limitations of §280A(c)(5) rather than §469.

Question – what if donate 5 days use of your vacation home to a silent auction held by a charity? Counts as personal use days.

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Using §469(i) – RRE-AP

Owner must actively participate in both year of loss and year loss claimed on return

Must own at least 10% of the activity Modified AGI per 469(i) must be below $150K

Deductions for AGI better than from AGI. Consider planning if AGI near $100K start of the phase-out range

No benefit if married persons file separately unless they live apart of entire year

No benefit to limited partner (unless future regs provide an exception)

Be sure is a rental (no rental exception met) Special rules for commercial revitalization deduction,

rehabilitation credit and low-income housing credit

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Recharacterization

If have income from passive activity or gain from disposition of passive activity or property used in passive activity, always check if any gain or income recharacterization rule applies.

Recharacterization rules only apply to income and gain, not losses.

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Participation reminders

Always check what both spouses do. If no work performed:

Might still meet one of the prior year’s MP tests Not all work counts:

-5T(f) Must be work customarily done by an owner. Not done merely to meet a test. Work done as “investor” won’t count unless involved in management.

Documentation (-5T(f)(4)) While contemporaneous daily time reports not required, need to

have something to show quantity and nature of work done, particularly if close to a MP threshold.

May also want to keep record of what others do to show that taxpayer did or did not meet a MP test. EX – for the substantially all or facts and circumstances tests

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SPA – significant participation activity Relevant for:

MP test Income recharacterization

Limited partners – SPA MP test n/a Income recharacterization rule can apply

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Activity involves mostly personal services, rather than use of capital May be a personal service activity per -5T(d)

if capital is not a material income-producing activity.

If yes, MP in any 3 prior years means continual MP.

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Debt

If debt proceeds traced to passive activity expenditure, then interest is PAD

Exceptions: Activity also involves non-passive activity assets Interest is QRI Interest is required to be capitalized (-2T(d)(3))

Debt to acquire interest in passthrough entity See Notice 89-35

COD income Check to see if PAI – Rev. Rul 92-92

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§1022 and individuals who died in 2010 §1022 Treatment of property acquired from a

decedent dying after December 31, 2009 (a) In general. Except as otherwise provided in this

section — (1) property acquired from a decedent dying after

December 31, 2009, shall be treated for purposes of this subtitle as transferred by gift, and

(2) the basis of the person acquiring property from such a decedent shall be the lesser of— (A) the adjusted basis of the decedent, or (B) the fair market value of the property at the date of the

decedent's death.