Q:

Subject: material participation

Hate to bother you during tax season, but I have gotten two different opinions from 2 different CPA.

Question:

I currently have several rent houses. I have full time employment elsewhere, so I do not qualify as a “professional,” but I do almost all of the work on the rent property myself. Can I qualify for material participation in this passive activity?

Thanks so much.

A:

The rules are explained in IRS Publication 925.
http://www.irs.gov/pub/irs-pdf/p925.pdf

http://www.irs.gov/publications/p925/index.html

Specifically:
http://www.irs.gov/publications/p925/ar02.html#d0e738

Material participation tests.    You materially participated in a trade or business activity for a tax year if you satisfy any of the following tests.

You participated in the activity for more than 500 hours.

1. Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who did not own any interest in the activity.
   
2. You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who did not own any interest in the activity) for the year.
   
3. The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you did not materially participate under any of the material participation tests, other than this test. See Significant Participation Passive Activities, under Recharacterization of Passive Income, later.
   
4. You materially participated in the activity for any 5 (whether or not consecutive) of the 10 immediately preceding tax years.
   
5. The activity is a personal service activity in which you materially participated for any 3 (whether or not consecutive) preceding tax years. An activity is a personal service activity if it involves the performance of personal services in the fields of health (including veterinary services), law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital is not a material income-producing factor.
   
6. Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the year.

 You did not materially participate in the activity under test (7) if you participated in the activity for 100 hours or less during the year. Your participation in managing the activity does not count in determining whether you materially participated under this test if:

• Any person other than you received compensation for managing the activity, or
  
• Any individual spent more hours during the tax year managing the activity than you did (regardless of whether the individual was compensated for the management services).

Participation.   In general, any work you do in connection with an activity in which you own an interest is treated as participation in the activity.

Work not usually performed by owners.   You do not treat the work you do in connection with an activity as participation in the activity if both of the following are true.

• The work is not work that is customarily done by the owner of that type of activity.
  
• One of your main reasons for doing the work is to avoid the disallowance of any loss or credit from the activity under the passive activity rules.

Participation as an investor.   You do not treat the work you do in your capacity as an investor in an activity as participation unless you are directly involved in the day-to-day management or operations of the activity. Work you do as an investor includes:

• Studying and reviewing financial statements or reports on operations of the activity,
  
• Preparing or compiling summaries or analyses of the finances or operations of the activity for your own use, and
  
• Monitoring the finances or operations of the activity in a nonmanagerial capacity.

Spouse's participation.   Your participation in an activity includes your spouse's participation. This applies even if your spouse did not own any interest in the activity and you and your spouse do not file a joint return for the year.

Proof of participation. You can use any reasonable method to prove your participation in an activity for the year. You do not have to keep contemporaneous daily time reports, logs, or similar documents if you can establish your participation in some other way. For example, you can show the services you performed and the approximate number of hours spent by using an appointment book, calendar, or narrative summary.


You should work with your own personal professional tax advisor to see if you qualify or not.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 3/09/2006 12:33:00 PM Send this post: