IRC §469 – Passive ActivitiesPart 5 (last one) Review + passive activity flowchart Reporting PALs and related recordkeeping Cautions in dealing with §469
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
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)
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.
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))”
What is a passive activity? Activity (-4)? No Wage, personal services, investment Yes Yes No Is gross income generated principally from use of tangible property? Tangible personal property used by customers? Working interest or trading personal property? No Yes No Trade or Business per -4(b)? No Section 469 n/a Yes Yes Yes Does any rental exception apply? Yes Is any MP test met? Yes No No Does 280A(c)(5) apply? No Is it rental of real estate by a real estate professional? Passive activity Yes No
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.
Activities * Worksheet 3 √ Sch D ¥ Sch E
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
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
Suspended PALs PAL from activities that are not disposed of in 2009
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)
Pub 925 example – Schedule D • Activity A $ 2,776 • Partnership 2 15,300 • Partnership 3 4,000 • Total $22,076
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.
§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
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.
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.
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
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.
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
SPA – significant participation activity • Relevant for: • MP test • Income recharacterization • Limited partners – • SPA MP test n/a • Income recharacterization rule can apply
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.
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
§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.