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Free tax programs 1. Free tax programs   Canceled Debts Table of Contents General RulesForm 1099-C Discounts and loan modifications Sales or other dispositions (such as foreclosures and repossessions) Abandonments Stockholder debt This chapter discusses the tax treatment of canceled debts. Free tax programs General Rules Generally, if a debt for which you are personally liable is forgiven or discharged for less than the full amount owed, the debt is considered canceled in whatever amount it remained unpaid. Free tax programs There are exceptions to this rule, discussed under Exceptions , later. Free tax programs Generally, you must include the canceled debt in your income. Free tax programs However, you may be able to exclude the canceled debt. Free tax programs See Exclusions , later. Free tax programs Example. Free tax programs John owed $1,000 to Mary. Free tax programs Mary agreed to accept and John paid $400 in satisfaction of the entire debt. Free tax programs John has canceled debt of $600. Free tax programs Example. Free tax programs Margaret owed $1,000 to Henry. Free tax programs Henry and Margaret agreed that Margaret would provide Henry with services (instead of money) in full satisfaction of the debt. Free tax programs Margaret does not have canceled debt. Free tax programs Instead, she has income from services. Free tax programs A debt includes any indebtedness: For which you are liable, or Subject to which you hold property. Free tax programs Debt for which you are personally liable is recourse debt. Free tax programs All other debt is nonrecourse debt. Free tax programs If you are not personally liable for the debt, you do not have ordinary income from the cancellation of debt unless you retain the collateral and either: The lender offers a discount for the early payment of the debt, or The lender agrees to a loan modification that results in the reduction of the principal balance of the debt. Free tax programs See Discounts and loan modifications , later. Free tax programs However, upon the disposition of the property securing a nonrecourse debt, the amount realized includes the entire unpaid amount of the debt, not just the FMV of the property. Free tax programs As a result, you may realize a gain or loss if the outstanding debt immediately before the disposition is more or less than your adjusted basis in the property. Free tax programs For more details on figuring your gain or loss, see chapter 2 of this publication or see Publication 544. Free tax programs There are several exceptions and exclusions that may result in part or all of a canceled debt being nontaxable. Free tax programs See Exceptions and Exclusions, later. Free tax programs You must report any taxable canceled debt as ordinary income on: Form 1040 or Form 1040NR, line 21, if the debt is a nonbusiness debt; Schedule C (Form 1040), line 6 (or Schedule C-EZ (Form 1040), line 1), if the debt is related to a nonfarm sole proprietorship; Schedule E (Form 1040), line 3, if the debt is related to nonfarm rental of real property; Form 4835, line 6, if the debt is related to a farm rental activity for which you use Form 4835 to report farm rental income based on crops or livestock produced by a tenant; or Schedule F (Form 1040), line 8, if the debt is farm debt and you are a farmer. Free tax programs Form 1099-C If you receive a Form 1099-C, that means an applicable entity has reported an identifiable event to the IRS regarding a debt you owe. Free tax programs The identifiable event may be an actual cancellation of the debt or it may be an event the applicable entity is required, solely for purposes of reporting to the IRS, to treat as a cancellation of debt. Free tax programs For information on the reasons an applicable entity files Form 1099-C, see Identifiable event codes, later. Free tax programs Unless you meet one of the exceptions or exclusions discussed later, this canceled debt is ordinary income and must be reported on the appropriate form discussed above. Free tax programs An applicable entity includes: A federal government agency, A financial institution, A credit union, and Any organization a significant trade or business of which is lending money. Free tax programs Identifiable event codes. Free tax programs    Box 6 of Form 1099-C should indicate the reason the creditor filed this form. Free tax programs The codes shown in box 6 are explained below. Free tax programs Also see the chart after the explanation for a quick reference guide for the codes used in Box 6. Free tax programs Note. Free tax programs Codes A through G and I identify specific occurrences resulting from an actual discharge of indebtedness. Free tax programs However, Code H, Expiration of nonpayment testing period, does not necessarily identify an actual discharge of indebtedness. Free tax programs Code A — Bankruptcy. Free tax programs Code A is used to identify cancellation of debt as a result of a title 11 bankruptcy case. Free tax programs See Bankruptcy , later. Free tax programs Code B — Other judicial debt relief. Free tax programs Code B is used to identify cancellation of debt as a result of a receivership, foreclosure, or similar federal or state court proceeding other than bankruptcy. Free tax programs Code C — Statute of limitations or expiration of deficiency period. Free tax programs Code C is used to identify cancellation of debt either when the statute of limitations for collecting the debt expires or when the statutory period for filing a claim or beginning a deficiency judgment proceeding expires. Free tax programs In the case of the expiration of a statute of limitations, an identifiable event occurs only if and when your affirmative defense of the statute of limitations is upheld in a final judgment or decision in a judicial proceeding, and the period for appealing the judgment or decision has expired. Free tax programs Code D — Foreclosure election. Free tax programs Code D is used to identify cancellation of debt when the creditor elects foreclosure remedies that statutorily end or bar the creditor's right to pursue collection of the debt. Free tax programs This event applies to a mortgage lender or holder who is barred from pursuing debt collection after a power of sale in the mortgage or deed of trust is exercised. Free tax programs Code E — Debt relief from probate or similar proceeding. Free tax programs Code E is used to identify cancellation of debt as a result of a probate court or similar legal proceeding. Free tax programs Code F — By agreement. Free tax programs Code F is used to identify cancellation of debt as a result of an agreement between the creditor and the debtor to cancel the debt at less than full consideration. Free tax programs Code G — Decision or policy to discontinue collection. Free tax programs Code G is used to identify cancellation of debt as a result of a decision or a defined policy of the creditor to discontinue collection activity and cancel the debt. Free tax programs For purposes of this identifiable event, a defined policy includes both a written policy and the creditor's established business practice. Free tax programs Code H — Expiration of nonpayment testing period. Free tax programs Code H is used to indicate that the creditor has not received a payment on the debt during a testing period ending on December 31, 2013. Free tax programs The testing period is a 36-month period increased by the number of months the creditor was prevented from engaging in collection activity by a stay in bankruptcy or similar bar under state or local law. Free tax programs This identifiable event applies only for a creditor that is a financial institution or credit union (and certain of their subsidiaries), the Federal Deposit Insurance Corporation (FDIC), Resolution Trust Corporation (RTC), National Credit Union Administration (NCUA), and other Federal executive agencies. Free tax programs Expiration of the nonpayment testing period does not necessarily result from an actual discharge of indebtedness. Free tax programs Code I — Other actual discharge before identifiable event. Free tax programs Code I is used to identify an actual cancellation of debt that occurs before any of the identifiable events described in codes A through H. Free tax programs Form 1099-C Reference Guide for Box 6 Identifiable Event Codes A Bankruptcy B Other judicial debt relief C Statute of limitations or expiration of deficiency period D Foreclosure election E Debt relief from probate or similar proceeding F By agreement G Decision or policy to discontinue collection H Expiration of nonpayment testing period I Other actual discharge before identifiable event Even if you did not receive a Form 1099-C, you must report canceled debt as gross income on your tax return unless one of the exceptions or exclusions described later applies. Free tax programs Amount of canceled debt. Free tax programs    The amount in box 2 of Form 1099-C may represent some or all of the debt that has been canceled or treated as canceled. Free tax programs The amount in box 2 will include principal and may include interest and other nonprincipal amounts (such as fees or penalties). Free tax programs Unless you meet one of the exceptions or exclusions discussed later, the amount of the debt that has been canceled is ordinary income and must be reported on the appropriate form as discussed earlier. Free tax programs Interest included in canceled debt. Free tax programs    If any interest is included in the amount of canceled debt in box 2, it will be shown in box 3. Free tax programs Whether the interest portion of the canceled debt must be included in your income depends on whether the interest would be deductible if you paid it. Free tax programs See Deductible Debt under Exceptions, later. Free tax programs Persons who each receive a Form 1099-C showing the full amount of debt. Free tax programs    If you and another person were jointly and severally liable for a canceled debt, each of you may get a Form 1099-C showing the entire amount of the canceled debt. Free tax programs However, you may not have to report that entire amount as income. Free tax programs The amount, if any, you must report depends on all the facts and circumstances, including: State law, The amount of debt proceeds each person received, How much of any interest deduction from the debt was claimed by each person, How much of the basis of any co-owned property bought with the debt proceeds was allocated to each co-owner, and Whether the canceled debt qualifies for any of the exceptions or exclusions described in this publication. Free tax programs See Example 3 under Insolvency, later. Free tax programs Discounts and loan modifications If a lender discounts (reduces) the principal balance of a loan because you pay it off early, or agrees to a loan modification (a “workout”) that includes a reduction in the principal balance of a loan, the amount of the discount or the amount of principal reduction is canceled debt. Free tax programs However, if the debt is nonrecourse and you did not retain the collateral, you do not have cancellation of the debt income. Free tax programs The amount of the canceled debt must be included in income unless one of the exceptions or exclusions described later applies. Free tax programs For more details, see Exceptions and Exclusions, later. Free tax programs Sales or other dispositions (such as foreclosures and repossessions) Recourse debt. Free tax programs   If you owned property that was subject to a recourse debt in excess of the FMV of the property, the lender's foreclosure or repossession of the property is treated as a sale or disposition of the property by you and may result in your realization of gain or loss. Free tax programs The gain or loss on the disposition of the property is measured by the difference between the FMV of the property at the time of the disposition and your adjusted basis (usually your cost) in the property. Free tax programs The character of the gain or loss (such as ordinary or capital) is determined by the character of the property. Free tax programs If the lender forgives all or part of the amount of the debt in excess of the FMV of the property, the cancellation of the excess debt may result in ordinary income. Free tax programs The ordinary income from the cancellation of debt (the excess of the canceled debt over the FMV of the property) must be included in your gross income reported on your tax return unless one of the exceptions or exclusions described later applies. Free tax programs For more details, see Exceptions and Exclusions, later. Free tax programs Nonrecourse debt. Free tax programs   If you owned property that was subject to a nonrecourse debt in excess of the FMV of the property, the lender's foreclosure on the property does not result in ordinary income from the cancellation of debt. Free tax programs The entire amount of the nonrecourse debt is treated as an amount realized on the disposition of the property. Free tax programs The gain or loss on the disposition of the property is measured by the difference between the total amount realized (the entire amount of the nonrecourse debt plus the amount of cash and the FMV of any property received) and your adjusted basis in the property. Free tax programs The character of the gain or loss is determined by the character of the property. Free tax programs More information. Free tax programs    See Publications 523, 544, and 551, and chapter 2 of this publication for more details. Free tax programs Abandonments Recourse debt. Free tax programs   If you abandon property that secures a debt for which you are personally liable (recourse debt) and the debt is canceled, you will realize ordinary income equal to the canceled debt. Free tax programs You must report this income on your tax return unless one of the exceptions or exclusions described later applies. Free tax programs For more details, see Exceptions and Exclusions, later. Free tax programs This income is separate from any amount realized from the abandonment of the property. Free tax programs For more details, see chapter 3. Free tax programs Nonrecourse debt. Free tax programs   If you abandon property that secures a debt for which you are not personally liable (nonrecourse debt), you may realize gain or loss but will not have cancellation of indebtedness income. Free tax programs Stockholder debt If you are a stockholder in a corporation and the corporation cancels or forgives your debt to it, the canceled debt is a constructive distribution. Free tax programs For more information, see Publication 542, Corporations. Free tax programs Prev  Up  Next   Home   More Online Publications
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Free tax programs Publication 925 - Main Content Table of Contents Passive Activity LimitsWho Must Use These Rules? Passive Activity Loss Passive Activity Credit Publicly Traded Partnership Excess Farm Loss Passive Activities Activities That Are Not Passive Activities Passive Activity Income and Deductions Grouping Your Activities Recharacterization of Passive Income Dispositions How To Report Your Passive Activity Loss Comprehensive ExampleGeneral Information At-Risk LimitsWho Is Affected? Activities Covered by the At-Risk Rules At-Risk Amounts Amounts Not At Risk Reductions of Amounts At Risk Recapture Rule How To Get Tax HelpLow Income Taxpayer Clinics Passive Activity Limits Who Must Use These Rules? The passive activity rules apply to: Individuals, Estates, Trusts (other than grantor trusts), Personal service corporations, and Closely held corporations. Free tax programs Even though the rules do not apply to grantor trusts, partnerships, and S corporations directly, they do apply to the owners of these entities. Free tax programs For information about personal service corporations and closely held corporations, including definitions and how the passive activity rules apply to these corporations, see Form 8810 and its instructions. Free tax programs Before applying the passive activity limits, you must first determine the amount of the deductions disallowed under the basis, excess farm loss, or at-risk rules. Free tax programs See Passive Activity Deductions, later. Free tax programs Passive Activity Loss Generally, the passive activity loss for the tax year is not allowed. Free tax programs However, there is a special allowance under which some or all of your passive activity loss may be allowed. Free tax programs See Special $25,000 allowance , later. Free tax programs Definition of passive activity loss. Free tax programs    Generally, your passive activity loss for the tax year is the excess of your passive activity deductions over your passive activity gross income. Free tax programs See Passive Activity Income and Deductions , later. Free tax programs   For a closely held corporation, the passive activity loss is the excess of passive activity deductions over the sum of passive activity gross income and net active income. Free tax programs For details on net active income, see the Instructions for Form 8810. Free tax programs For the definition of passive activity gross income, see Passive Activity Income , later. Free tax programs For the definition of passive activity deductions, see Passive Activity Deductions , later. Free tax programs Identification of Disallowed Passive Activity Deductions If all or a part of your passive activity loss is disallowed for the tax year, you may need to allocate the disallowed passive activity loss among different passive activities and among different deductions within a passive activity. Free tax programs Allocation of disallowed passive activity loss among activities. Free tax programs   If all or any part of your passive activity loss is disallowed for the tax year, a ratable portion of the loss (if any) from each of your passive activities is disallowed. Free tax programs The ratable portion of a loss from an activity is computed by multiplying the passive activity loss that is disallowed for the tax year by the fraction obtained by dividing: The loss from the activity for the tax year; by The sum of the losses for the tax year from all activities having losses for the tax year. Free tax programs Use Worksheet 5 of Form 8582 to figure the ratable portion of the loss from each activity that is disallowed. Free tax programs Loss from an activity. Free tax programs   The term “loss from an activity” means: The amount by which the passive activity deductions (defined later) from the activity for the tax year exceed the passive activity gross income (defined later) from the activity for the tax year; reduced by Any part of such amount that is allowed under the Special $25,000 Allowance , later. Free tax programs   If your passive activity gross income from significant participation passive activities (defined later) for the tax year is more than your passive activity deductions from those activities for the tax year, those activities shall be treated, solely for purposes of figuring your loss from the activity, as a single activity that does not have a loss for such taxable year. Free tax programs See Significant Participation Passive Activities , later. Free tax programs Example. Free tax programs John Pine holds interests in three passive activities, A, B, and C. Free tax programs The gross income and deductions from these activities for the taxable year are as follows:   A B C Total Gross income $7,000 $4,000 $12,000 $23,000 Deductions (16,000) (20,000) (8,000) (44,000)           Net income (loss) ($9,000) ($16,000) $4,000 ($21,000)   John Pine’s $21,000 passive activity loss for the taxable year is disallowed. Free tax programs Therefore, a ratable portion of the losses from activities A and B is disallowed. Free tax programs He figures the disallowed portion of each loss as follows: A: $21,000 x $9,000/$25,000 $7,560 B: $21,000 x $16,000/$25,000 13,440     Total $21,000 Allocation within loss activities. Free tax programs   If all or any part of your loss from an activity is disallowed under Allocation of disallowed passive activity loss among activities for the tax year, a ratable portion of each of your passive activity deductions (defined later), other than an excluded deduction (defined below) from such activity is disallowed. Free tax programs The ratable portion of a passive activity deduction is the amount of the disallowed portion of the loss from the activity for the tax year multiplied by the fraction obtained by dividing: The amount of such deduction; by The sum of all of your passive activity deductions (other than excluded deductions) from that activity from the tax year. Free tax programs Excluded deductions. Free tax programs    “Excluded deduction” means any passive activity deduction that is taken into account in computing your net income from an item of property for a taxable year in which an amount of the taxpayer's gross income from such item of property is treated as not from a passive activity. Free tax programs See Recharacterization of Passive Income , later. Free tax programs Separately identified deductions. Free tax programs   In identifying the deductions from an activity that are disallowed, you do not need to account separately for a deduction unless such deduction may, if separately taken into account, result in an income tax liability for any tax year different from that which would result were such deduction not taken into account separately. Free tax programs   Use Form 8582, Worksheet 7, for any activity if you have passive activity deductions for that activity that must be separately identified. Free tax programs   Deductions that must be accounted for separately include (but are not limited to) the following deductions. Free tax programs Deductions that arise in a rental real estate activity in tax years in which you actively participate in such activity. Free tax programs See Active participation , later. Free tax programs Deductions that arise in a rental real estate activity in tax years in which you do not actively participate in such activity. Free tax programs See Active participation , later. Free tax programs Losses from sales or exchanges of capital assets. Free tax programs Section 1231 losses. Free tax programs See Section 1231 Gains and Losses in Publication 544, Sales and Other Disposition of Assets, for more information. Free tax programs Carryover of Disallowed Deductions In the case of an activity with respect to which any deductions or credits are disallowed for a taxable year (the loss activity), the disallowed deductions are allocated among your activities for the next tax year in a manner that reasonably reflects the extent to which each activity continues the loss activity. Free tax programs The disallowed deductions or credits allocated to an activity under the preceding sentence are treated as deductions or credits from the activity for the next tax year. Free tax programs For more information, see Regulations section 1. Free tax programs 469-1(f)(4). Free tax programs Passive Activity Credit Generally, the passive activity credit for the tax year is disallowed. Free tax programs The passive activity credit is the amount by which the sum of all your credits subject to the passive activity rules exceed your regular tax liability allocable to all passive activities for the tax year. Free tax programs Credits that are included in figuring the general business credit are subject to the passive activity rules. Free tax programs See the Instructions for Form 8582-CR for more information. Free tax programs Publicly Traded Partnership You must apply the rules in this part separately to your income or loss from a passive activity held through a publicly traded partnership (PTP). Free tax programs You also must apply the limit on passive activity credits separately to your credits from a passive activity held through a PTP. Free tax programs You can offset deductions from passive activities of a PTP only against income or gain from passive activities of the same PTP. Free tax programs Likewise, you can offset credits from passive activities of a PTP only against the tax on the net passive income from the same PTP. Free tax programs This separate treatment rule also applies to a regulated investment company holding an interest in a PTP for the items attributable to that interest. Free tax programs For more information on how to apply the passive activity loss rules to PTPs, and on how to apply the limit on passive activity credits to PTPs, see Publicly Traded Partnerships (PTPs) in the Instructions for Forms 8582 and 8582-CR, respectively. Free tax programs Excess Farm Loss If you receive an applicable subsidy for any tax year and you have an excess farm loss for the tax year, special rules apply. Free tax programs These rules do not apply to C corporations. Free tax programs For information, see the Instructions for Schedule F (Form 1040), Profit or Loss From Farming. Free tax programs Passive Activities There are two kinds of passive activities. Free tax programs Trade or business activities in which you do not materially participate during the year. Free tax programs Rental activities, even if you do materially participate in them, unless you are a real estate professional. Free tax programs Material participation in a trade or business is discussed later, under Activities That Are Not Passive Activities . Free tax programs Treatment of former passive activities. Free tax programs   A former passive activity is an activity that was a passive activity in any earlier tax year, but is not a passive activity in the current tax year. Free tax programs You can deduct a prior year's unallowed loss from the activity up to the amount of your current year net income from the activity. Free tax programs Treat any remaining prior year unallowed loss like you treat any other passive loss. Free tax programs   In addition, any prior year unallowed passive activity credits from a former passive activity offset the allocable part of your current year tax liability. Free tax programs The allocable part of your current year tax liability is that part of this year's tax liability that is allocable to the current year net income from the former passive activity. Free tax programs You figure this after you reduce your net income from the activity by any prior year unallowed loss from that activity (but not below zero). Free tax programs Trade or Business Activities A trade or business activity is an activity that: Involves the conduct of a trade or business (that is, deductions would be allowable under section 162 of the Internal Revenue Code if other limitations, such as the passive activity rules, did not apply), Is conducted in anticipation of starting a trade or business, or Involves research or experimental expenditures that are deductible under Internal Revenue Code section 174 (or that would be deductible if you chose to deduct rather than capitalize them). Free tax programs A trade or business activity does not include a rental activity or the rental of property that is incidental to an activity of holding the property for investment. Free tax programs You generally report trade or business activities on Schedule C, C-EZ, F, or in Part II or III of Schedule E. Free tax programs Rental Activities A rental activity is a passive activity even if you materially participated in that activity, unless you materially participated as a real estate professional. Free tax programs See Real Estate Professional under Activities That Are Not Passive Activities, later. Free tax programs An activity is a rental activity if tangible property (real or personal) is used by customers or held for use by customers, and the gross income (or expected gross income) from the activity represents amounts paid (or to be paid) mainly for the use of the property. Free tax programs It does not matter whether the use is under a lease, a service contract, or some other arrangement. Free tax programs Exceptions. Free tax programs   Your activity is not a rental activity if any of the following apply. Free tax programs The average period of customer use of the property is 7 days or less. Free tax programs You figure the average period of customer use by dividing the total number of days in all rental periods by the number of rentals during the tax year. Free tax programs If the activity involves renting more than one class of property, multiply the average period of customer use of each class by a fraction. Free tax programs The numerator of the fraction is the gross rental income from that class of property and the denominator is the activity's total gross rental income. Free tax programs The activity's average period of customer use will equal the sum of the amounts for each class. Free tax programs The average period of customer use of the property, as figured in (1) above, is 30 days or less and you provide significant personal services with the rentals. Free tax programs Significant personal services include only services performed by individuals. Free tax programs To determine if personal services are significant, all relevant facts and circumstances are taken into consideration, including the frequency of the services, the type and amount of labor required to perform the services, and the value of the services relative to the amount charged for use of the property. Free tax programs Significant personal services do not include the following. Free tax programs Services needed to permit the lawful use of the property, Services to repair or improve property that would extend its useful life for a period substantially longer than the average rental, and Services that are similar to those commonly provided with long-term rentals of real estate, such as cleaning and maintenance of common areas or routine repairs. Free tax programs You provide extraordinary personal services in making the rental property available for customer use. Free tax programs Services are extraordinary personal services if they are performed by individuals and the customers' use of the property is incidental to their receipt of the services. Free tax programs The rental is incidental to a nonrental activity. Free tax programs The rental of property is incidental to an activity of holding property for investment if the main purpose of holding the property is to realize a gain from its appreciation and the gross rental income from the property is less than 2% of the smaller of the property's unadjusted basis or fair market value. Free tax programs The unadjusted basis of property is its cost not reduced by depreciation or any other basis adjustment. Free tax programs The rental of property is incidental to a trade or business activity if all of the following apply. Free tax programs You own an interest in the trade or business activity during the year. Free tax programs The rental property was used mainly in that trade or business activity during the current year, or during at least 2 of the 5 preceding tax years. Free tax programs Your gross rental income from the property is less than 2% of the smaller of its unadjusted basis or fair market value. Free tax programs Lodging provided to an employee or the employee's spouse or dependents is incidental to the activity or activities in which the employee performs services if the lodging is furnished for the employer's convenience. Free tax programs You customarily make the rental property available during defined business hours for nonexclusive use by various customers. Free tax programs You provide the property for use in a nonrental activity in your capacity as an owner of an interest in the partnership, S corporation, or joint venture conducting that activity. Free tax programs    If you meet any of the exceptions listed above, see the instructions for Form 8582 for information about how to report any income or loss from the activity. Free tax programs Special $25,000 allowance. Free tax programs   If you or your spouse actively participated in a passive rental real estate activity, the amount of the passive activity loss that is disallowed is decreased and you therefore can deduct up to $25,000 of loss from the activity from your nonpassive income. Free tax programs This special allowance is an exception to the general rule disallowing the passive activity loss. Free tax programs Similarly, you can offset credits from the activity against the tax on up to $25,000 of nonpassive income after taking into account any losses allowed under this exception. Free tax programs   If you are married, filing a separate return, and lived apart from your spouse for the entire tax year, your special allowance cannot be more than $12,500. Free tax programs If you lived with your spouse at any time during the year and are filing a separate return, you cannot use the special allowance to reduce your nonpassive income or tax on nonpassive income. Free tax programs   The maximum special allowance is reduced if your modified adjusted gross income exceeds certain amounts. Free tax programs See Phaseout rule , later. Free tax programs Example. Free tax programs Kate, a single taxpayer, has $70,000 in wages, $15,000 income from a limited partnership, a $26,000 loss from rental real estate activities in which she actively participated, and is not subject to the modified adjusted gross income phaseout rule. Free tax programs She can use $15,000 of her $26,000 loss to offset her $15,000 passive income from the partnership. Free tax programs She actively participated in her rental real estate activities, so she can use the remaining $11,000 rental real estate loss to offset $11,000 of her nonpassive income (wages). Free tax programs Commercial revitalization deduction (CRD). Free tax programs   The special allowance must first be applied to losses from rental real estate activities figured without the CRD. Free tax programs Any remaining part of the special allowance is available for the CRD from the rental real estate activities and is not subject to the active participation rules or the phaseout based on modified adjusted gross income. Free tax programs You cannot claim a CRD for a building placed in service after December 31, 2009. Free tax programs Active participation. Free tax programs   Active participation is not the same as material participation (defined later). Free tax programs Active participation is a less stringent standard than material participation. Free tax programs For example, you may be treated as actively participating if you make management decisions in a significant and bona fide sense. Free tax programs Management decisions that count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and similar decisions. Free tax programs   Only individuals can actively participate in rental real estate activities. Free tax programs However, a decedent's estate is treated as actively participating for its tax years ending less than 2 years after the decedent's death, if the decedent would have satisfied the active participation requirement for the activity for the tax year the decedent died. Free tax programs   A decedent's qualified revocable trust can also be treated as actively participating if both the trustee and the executor (if any) of the estate choose to treat the trust as part of the estate. Free tax programs The choice applies to tax years ending after the decedent's death and before: 2 years after the decedent's death if no estate tax return is required, or 6 months after the estate tax liability is finally determined if an estate tax return is required. Free tax programs   The choice is irrevocable and cannot be made later than the due date for the estate's first income tax return (including any extensions). Free tax programs   Limited partners are not treated as actively participating in a partnership's rental real estate activities. Free tax programs   You are not treated as actively participating in a rental real estate activity unless your interest in the activity (including your spouse's interest) was at least 10% (by value) of all interests in the activity throughout the year. Free tax programs   Active participation is not required to take the low-income housing credit, the rehabilitation investment credit, or CRD from rental real estate activities. Free tax programs Example. Free tax programs Mike, a single taxpayer, had the following income and loss during the tax year: Salary $42,300 Dividends 300 Interest 1,400 Rental loss (4,000) The rental loss came from a house Mike owned. Free tax programs He advertised and rented the house to the current tenant himself. Free tax programs He also collected the rents and did the repairs or hired someone to do them. Free tax programs Even though the rental loss is a loss from a passive activity, Mike can use the entire $4,000 loss to offset his other income because he actively participated. Free tax programs Phaseout rule. Free tax programs   The maximum special allowance of $25,000 ($12,500 for married individuals filing separate returns and living apart at all times during the year) is reduced by 50% of the amount of your modified adjusted gross income that is more than $100,000 ($50,000 if you are married filing separately). Free tax programs If your modified adjusted gross income is $150,000 or more ($75,000 or more if you are married filing separately), you generally cannot use the special allowance. Free tax programs    Modified adjusted gross income for this purpose is your adjusted gross income figured without the following. Free tax programs Taxable social security and tier 1 railroad retirement benefits. Free tax programs Deductible contributions to individual retirement accounts (IRAs) and section 501(c)(18) pension plans. Free tax programs The exclusion from income of interest from qualified U. Free tax programs S. Free tax programs savings bonds used to pay qualified higher education expenses. Free tax programs The exclusion from income of amounts received from an employer's adoption assistance program. Free tax programs Passive activity income or loss included on Form 8582. Free tax programs Any rental real estate loss allowed because you materially participated in the rental activity as a Real Estate Professional (as discussed later, under Activities That Are Not Passive Activities). Free tax programs Any overall loss from a publicly traded partnership (see Publicly Traded Partnerships (PTPs) in the instructions for Form 8582). Free tax programs The deduction for the employer-equivalent portion of self-employment tax. Free tax programs The deduction for domestic production activities. Free tax programs The deduction allowed for interest on student loans. Free tax programs The deduction for qualified tuition and related expenses. Free tax programs Example. Free tax programs During 2013, John was unmarried and was not a real estate professional. Free tax programs For 2013, he had $120,000 in salary and a $31,000 loss from his rental real estate activities in which he actively participated. Free tax programs His modified adjusted gross income is $120,000. Free tax programs When he files his 2013 return, he can deduct only $15,000 of his passive activity loss. Free tax programs He must carry over the remaining $16,000 passive activity loss to 2014. Free tax programs He figures his deduction and carryover as follows: Adjusted gross income, modified as required $120,000       Minus amount not subject to phaseout 100,000 Amount subject to phaseout rule $20,000 Multiply by 50% × 50% Required reduction to special allowance $10,000 Maximum special allowance $25,000 Minus required reduction (see above) 10,000 Adjusted special allowance $15,000 Passive loss from rental real estate $31,000 Deduction allowable/Adjusted  special allowance (see above) 15,000       Amount that must be carried forward $16,000 Exceptions to the phaseout rules. Free tax programs   A higher phaseout range applies to rehabilitation investment credits from rental real estate activities. Free tax programs For those credits, the phaseout of the $25,000 special allowance starts when your modified adjusted gross income exceeds $200,000 ($100,000 if you are a married individual filing a separate return and living apart at all times during the year). Free tax programs   There is no phaseout of the $25,000 special allowance for low-income housing credits or for the CRD. Free tax programs Ordering rules. Free tax programs   If you have more than one of the exceptions to the phaseout rules in the same tax year, you must apply the $25,000 phaseout against your passive activity losses and credits in the following order. Free tax programs The portion of passive activity losses not attributable to the CRD. Free tax programs The portion of passive activity losses attributable to the CRD. Free tax programs The portion of passive activity credits attributable to credits other than the rehabilitation and low-income housing credits. Free tax programs The portion of passive activity credits attributable to the rehabilitation credit. Free tax programs The portion of passive activity credits attributable to the low-income housing credit. Free tax programs Activities That Are Not Passive Activities The following are not passive activities. Free tax programs Trade or business activities in which you materially participated for the tax year. Free tax programs A working interest in an oil or gas well which you hold directly or through an entity that does not limit your liability (such as a general partner interest in a partnership). Free tax programs It does not matter whether you materially participated in the activity for the tax year. Free tax programs However, if your liability was limited for part of the year (for example, you converted your general partner interest to a limited partner interest during the year) and you had a net loss from the well for the year, some of your income and deductions from the working interest may be treated as passive activity gross income and passive activity deductions. Free tax programs  See Temporary Regulations section 1. Free tax programs 469-1T(e)(4)(ii). Free tax programs The rental of a dwelling unit that you also used for personal purposes during the year for more than the greater of 14 days or 10% of the number of days during the year that the home was rented at a fair rental. Free tax programs An activity of trading personal property for the account of those who own interests in the activity. Free tax programs See Temporary Regulations section 1. Free tax programs 469-1T(e)(6). Free tax programs Rental real estate activities in which you materially participated as a real estate professional. Free tax programs See Real Estate Professional , later. Free tax programs You should not enter income and losses from these activities on Form 8582. Free tax programs Instead, enter them on the forms or schedules you would normally use. Free tax programs Material Participation A trade or business activity is not a passive activity if you materially participated in the activity. Free tax programs Material participation tests. Free tax programs    You materially participated in a trade or business activity for a tax year if you satisfy any of the following tests. Free tax programs You participated in the activity for more than 500 hours. Free tax programs 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. Free tax programs 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. Free tax programs The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. Free tax programs 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. Free tax programs See Significant Participation Passive Activities , under Recharacterization of Passive Income, later. Free tax programs You materially participated in the activity for any 5 (whether or not consecutive) of the 10 immediately preceding tax years. Free tax programs The activity is a personal service activity in which you materially participated for any 3 (whether or not consecutive) preceding tax years. Free tax programs 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. Free tax programs Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the year. Free tax programs   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. Free tax programs 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). Free tax programs Participation. Free tax programs   In general, any work you do in connection with an activity in which you own an interest is treated as participation in the activity. Free tax programs Work not usually performed by owners. Free tax programs   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. Free tax programs The work is not work that is customarily done by the owner of that type of activity. Free tax programs 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. Free tax programs Participation as an investor. Free tax programs   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. Free tax programs 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. Free tax programs Spouse's participation. Free tax programs   Your participation in an activity includes your spouse's participation. Free tax programs 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. Free tax programs Proof of participation. Free tax programs You can use any reasonable method to prove your participation in an activity for the year. Free tax programs You do not have to keep contemporaneous daily time reports, logs, or similar documents if you can establish your participation in some other way. Free tax programs 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. Free tax programs Limited partners. Free tax programs   If you owned an activity as a limited partner, you generally are not treated as materially participating in the activity. Free tax programs However, you are treated as materially participating in the activity if you met test (1), (5), or (6) under Material participation tests , discussed earlier, for the tax year. Free tax programs   You are not treated as a limited partner, however, if you also were a general partner in the partnership at all times during the partnership's tax year ending with or within your tax year (or, if shorter, during that part of the partnership's tax year in which you directly or indirectly owned your limited partner interest). Free tax programs Retired or disabled farmer and surviving spouse of a farmer. Free tax programs   If you are a retired or disabled farmer, you are treated as materially participating in a farming activity if you materially participated for 5 or more of the 8 years before your retirement or disability. Free tax programs Similarly, if you are a surviving spouse of a farmer, you are treated as materially participating in a farming activity if the real property used in the activity meets the estate tax rules for special valuation of farm property passed from a qualifying decedent, and you actively manage the farm. Free tax programs Corporations. Free tax programs   A closely held corporation or a personal service corporation is treated as materially participating in an activity only if one or more shareholders holding more than 50% by value of the outstanding stock of the corporation materially participate in the activity. Free tax programs   A closely held corporation can also satisfy the material participation standard by meeting the first two requirements for the qualifying business exception from the at-risk limits. Free tax programs See Special exception for qualified corporations under Activities Covered by the At-Risk Rules, later. Free tax programs Real Estate Professional Generally, rental activities are passive activities even if you materially participated in them. Free tax programs However, if you qualified as a real estate professional, rental real estate activities in which you materially participated are not passive activities. Free tax programs For this purpose, each interest you have in a rental real estate activity is a separate activity, unless you choose to treat all interests in rental real estate activities as one activity. Free tax programs See the Instructions for Schedule E (Form 1040), Supplemental Income and Loss, for information about making this choice. Free tax programs If you qualified as a real estate professional for 2013, report income or losses from rental real estate activities in which you materially participated as nonpassive income or losses, and complete line 43 of Schedule E (Form 1040). Free tax programs If you also have an unallowed loss from these activities from an earlier year when you did not qualify, see Treatment of former passive activities under Passive Activities, earlier. Free tax programs Qualifications. Free tax programs   You qualified as a real estate professional for the year if you met both of the following requirements. Free tax programs More than half of the personal services you performed in all trades or businesses during the tax year were performed in real property trades or businesses in which you materially participated. Free tax programs You performed more than 750 hours of services during the tax year in real property trades or businesses in which you materially participated. Free tax programs   Do not count personal services you performed as an employee in real property trades or businesses unless you were a 5% owner of your employer. Free tax programs You were a 5% owner if you owned (or are considered to have owned) more than 5% of your employer's outstanding stock, outstanding voting stock, or capital or profits interest. Free tax programs   If you file a joint return, do not count your spouse's personal services to determine whether you met the preceding requirements. Free tax programs However, you can count your spouse's participation in an activity in determining if you materially participated. Free tax programs Real property trades or businesses. Free tax programs   A real property trade or business is a trade or business that does any of the following with real property. Free tax programs Develops or redevelops it. Free tax programs Constructs or reconstructs it. Free tax programs Acquires it. Free tax programs Converts it. Free tax programs Rents or leases it. Free tax programs Operates or manages it. Free tax programs Brokers it. Free tax programs Closely held corporations. Free tax programs   A closely held corporation can qualify as a real estate professional if more than 50% of the gross receipts for its tax year came from real property trades or businesses in which it materially participated. Free tax programs Passive Activity Income and Deductions In figuring your net income or loss from a passive activity, take into account only passive activity income and passive activity deductions. Free tax programs Self-charged interest. Free tax programs   Certain self-charged interest income or deductions may be treated as passive activity gross income or passive activity deductions if the loan proceeds are used in a passive activity. Free tax programs   Generally, self-charged interest income and deductions result from loans between you and a partnership or S corporation in which you had a direct or indirect ownership interest. Free tax programs This includes both loans you made to the partnership or S corporation and loans the partnership or S corporation made to you. Free tax programs   It also includes loans from one partnership or S corporation to another partnership or S corporation if each owner in the borrowing entity has the same proportional ownership interest in the lending entity. Free tax programs    Exception. Free tax programs The self-charged interest rules do not apply to your interest in a partnership or S corporation if the entity made an election under Regulations section 1. Free tax programs 469-7(g) to avoid the application of these rules. Free tax programs For more details on the self-charged interest rules, see Regulations section 1. Free tax programs 469-7. Free tax programs Passive Activity Income Passive activity income includes all income from passive activities and generally includes gain from disposition of an interest in a passive activity or property used in a passive activity. Free tax programs Passive activity income does not include the following items. Free tax programs Income from an activity that is not a passive activity. Free tax programs These activities are discussed under Activities That Are Not Passive Activities , earlier. Free tax programs Portfolio income. Free tax programs This includes interest, dividends, annuities, and royalties not derived in the ordinary course of a trade or business. Free tax programs It includes gain or loss from the disposition of property that produces these types of income or that is held for investment. Free tax programs The exclusion for portfolio income does not apply to self-charged interest treated as passive activity income. Free tax programs For more information on self-charged interest, see Self-charged interest , earlier. Free tax programs Personal service income. Free tax programs This includes salaries, wages, commissions, self-employment income from trade or business activities in which you materially participated, deferred compensation, taxable social security and other retirement benefits, and payments from partnerships to partners for personal services. Free tax programs Income from positive section 481 adjustments allocated to activities other than passive activities. Free tax programs (Section 481 adjustments are adjustments that must be made due to changes in your accounting method. Free tax programs ) Income or gain from investments of working capital. Free tax programs Income from an oil or gas property if you treated any loss from a working interest in the property for any tax year beginning after 1986 as a nonpassive loss, as discussed in item (2) under Activities That Are Not Passive Activities , earlier. Free tax programs This also applies to income from other oil and gas property the basis of which is determined wholly or partly by the basis of the property in the preceding sentence. Free tax programs Any income from intangible property, such as a patent, copyright, or literary, musical, or artistic composition, if your personal efforts significantly contributed to the creation of the property. Free tax programs Any other income that must be treated as nonpassive income. Free tax programs See Recharacterization of Passive Income , later. Free tax programs Overall gain from any interest in a publicly traded partnership. Free tax programs See Publicly Traded Partnerships (PTPs) in the instructions for Form 8582. Free tax programs State, local, and foreign income tax refunds. Free tax programs Income from a covenant not to compete. Free tax programs Reimbursement of a casualty or theft loss included in gross income to recover all or part of a prior year loss deduction, if the loss deduction was not a passive activity deduction. Free tax programs Alaska Permanent Fund dividends. Free tax programs Cancellation of debt income, if at the time the debt is discharged the debt is not allocated to passive activities under the interest expense allocation rules. Free tax programs See chapter 4 of Publication 535, Business Expenses, for information about the rules for allocating interest. Free tax programs Disposition of property interests. Free tax programs   Gain on the disposition of an interest in property generally is passive activity income if, at the time of the disposition, the property was used in an activity that was a passive activity in the year of disposition. Free tax programs The gain generally is not passive activity income if, at the time of disposition, the property was used in an activity that was not a passive activity in the year of disposition. Free tax programs An exception to this general rule may apply if you previously used the property in a different activity. Free tax programs Exception for more than one use in the preceding 12 months. Free tax programs   If you used the property in more than one activity during the 12-month period before its disposition, you must allocate the gain between the activities on a basis that reasonably reflects the property's use during that period. Free tax programs Any gain allocated to a passive activity is passive activity income. Free tax programs   For this purpose, an allocation of the gain solely to the activity in which the property was mainly used during that period reasonably reflects the property's use if the fair market value of your interest in the property is not more than the lesser of: $10,000, or 10% of the total of the fair market value of your interest in the property and the fair market value of all other property used in that activity immediately before the disposition. Free tax programs Exception for substantially appreciated property. Free tax programs   The gain is passive activity income if the fair market value of the property at disposition was more than 120% of its adjusted basis and either of the following conditions applies. Free tax programs You used the property in a passive activity for 20% of the time you held your interest in the property. Free tax programs You used the property in a passive activity for the entire 24-month period before its disposition. Free tax programs If neither condition applies, the gain is not passive activity income. Free tax programs However, it is treated as portfolio income only if you held the property for investment for more than half of the time you held it in nonpassive activities. Free tax programs   For this purpose, treat property you held through a corporation (other than an S corporation) or other entity whose owners receive only portfolio income as property held in a nonpassive activity and as property held for investment. Free tax programs Also, treat the date you agree to transfer your interest for a fixed or determinable amount as the disposition date. Free tax programs   If you used the property in more than one activity during the 12-month period before its disposition, this exception applies only to the part of the gain allocated to a passive activity under the rules described in the preceding discussion. Free tax programs Disposition of property converted to inventory. Free tax programs   If you disposed of property that you had converted to inventory from its use in another activity (for example, you sold condominium units you previously held for use in a rental activity), a special rule may apply. Free tax programs Under this rule, you disregard the property's use as inventory and treat it as if it were still used in that other activity at the time of disposition. Free tax programs This rule applies only if you meet all of the following conditions. Free tax programs At the time of disposition, you held your interest in the property in a dealing activity (an activity that involves holding the property or similar property mainly for sale to customers in the ordinary course of a trade or business). Free tax programs Your other activities included a nondealing activity (an activity that does not involve holding similar property for sale to customers in the ordinary course of a trade or business) in which you used the property for more than 80% of the period you held it. Free tax programs You did not acquire or hold your interest in the property for the main purpose of selling it to customers in the ordinary course of a trade or business. Free tax programs Passive Activity Deductions Generally, a deduction is a passive activity deduction for a taxable year if and only if such deduction either: Arises in connection with the conduct of an activity that is a passive activity for the tax year; or Is treated as a deduction from an activity for the tax year because it was disallowed by the passive activity rules in the preceding year and carried forward to the tax year. Free tax programs For purposes of item (1), above, an item of deduction arises in the taxable year in which the item would be allowable as a deduction under the taxpayer's method of accounting if taxable income for all taxable years were determined without regard to the passive activity rules and without regard to the basis, excess farm loss, and at-risk limits. Free tax programs See Coordination with other limitations on deductions that apply before the passive activity rules , later. Free tax programs Passive activity deductions generally include losses from dispositions of property used in a passive activity at the time of the disposition and losses from a disposition of less than your entire interest in a passive activity. Free tax programs Exceptions. Free tax programs   Passive activity deductions do not include the following items. Free tax programs Deductions for expenses (other than interest expense) that are clearly and directly allocable to portfolio income. Free tax programs Qualified home mortgage interest, capitalized interest expenses, and other interest expenses (other than self-charged interest) properly allocable to passive activities. Free tax programs For more information on self-charged interest, see Self-charged interest under Passive Activity Income and Deductions, earlier. Free tax programs Losses from dispositions of property that produce portfolio income or property held for investment. Free tax programs State, local, and foreign income taxes. Free tax programs Miscellaneous itemized deductions that may be disallowed because of the 2%-of-adjusted-gross-income limit. Free tax programs Charitable contribution deductions. Free tax programs Net operating loss deductions. Free tax programs Percentage depletion carryovers for oil and gas wells. Free tax programs Capital loss carrybacks and carryovers. Free tax programs Items of deduction from a passive activity that are disallowed under the limits on deductions that apply before the passive activity rules. Free tax programs See Coordination with other limitations on deductions that apply before the passive activity rules , later. Free tax programs Deductions and losses that would have been allowed for tax years beginning before 1987 but for basis or at-risk limits. Free tax programs Net negative section 481 adjustments allocated to activities other than passive activities. Free tax programs (Section 481 adjustments are adjustments required due to changes in accounting methods. Free tax programs ) Casualty and theft losses, unless losses similar in cause and severity recur regularly in the activity. Free tax programs The deduction for the employer-equivalent portion of self-employment tax. Free tax programs Coordination with other limitations on deductions that apply before the passive activity rules. Free tax programs   An item of deduction from a passive activity that is disallowed for a tax year under the basis or at-risk limitations is not a passive activity deduction for the tax year. Free tax programs The following sections provide rules for figuring the extent to which items of deduction from a passive activity are disallowed for a tax year under the basis or at-risk limitations. Free tax programs Proration of deductions disallowed under basis limitations. Free tax programs   If any amount of your distributive share of a partnership's loss for the tax year is disallowed under the basis limitation, a ratable portion of your distributive share of each item of deduction or loss of the partnership is disallowed for the tax year. Free tax programs For this purpose, the ratable portion of an item of deduction or loss is the amount of such item multiplied by the fraction obtained by dividing: The amount of your distributive share of partnership loss that is disallowed for the taxable year; by The sum of your distributive shares of all items of deduction and loss of the partnership for the tax year. Free tax programs   If any amount of your pro rata share of an S corporation's loss for the tax year is disallowed under the basis limitation, a ratable portion of your pro rata share of each item of deduction or loss of the S corporation is disallowed for the tax year. Free tax programs For this purpose, the ratable portion of an item of deduction or loss is the amount of such item multiplied by the fraction obtained by dividing: The amount of your share of S corporation loss that is disallowed for the tax year; by The sum of your pro rata shares of all items of deduction and loss of the corporation for the tax year. Free tax programs Proration of deductions disallowed under at-risk limitation. Free tax programs   If any amount of your loss from an activity (as defined in Activities Covered by the At-Risk Rules , later) is disallowed under the at-risk rules for the tax year, a ratable portion of each item of deduction or loss from the activity is disallowed for the tax year. Free tax programs For this purpose, the ratable portion of an item of deduction or loss is the amount of such item multiplied by the fraction obtained by dividing: The amount of the loss from the activity that is disallowed for the tax year; by The sum of all deductions from the activity for the taxable year. Free tax programs Coordination of basis and at-risk limitations. Free tax programs   The portion of any item of deduction or loss that is disallowed for the tax year under the basis limitations is not taken into account for the taxable year in determining the loss from an activity (as defined in Activities Covered by the At-Risk Rules , later) for purposes of applying the at-risk rules. Free tax programs Separately identified items of deduction and loss. Free tax programs   In identifying the items of deduction and loss from an activity that are not disallowed under the basis and at-risk limitations (and that therefore may be treated as passive activity deductions), you need not account separately for any item of deduction or loss unless such item may, if separately taken into account, result in an income tax liability different from that which would result were such item of deduction or loss taken into account separately. Free tax programs   Items of deduction or loss that must be accounted for separately include (but are not limited to) items of deduction or loss that: Are attributable to separate activities. Free tax programs See Grouping Your Activities , later. Free tax programs Arise in a rental real estate activity in tax years in which you actively participate in such activity; Arise in a rental real estate activity in taxable years in which you do not actively participate in such activity; Arose in a taxable year beginning before 1987 and were not allowed for such taxable year under the basis or at-risk limitations; Are taken into account under section 613A(d) (relating to limitations on certain depletion deductions); Are taken into account under section 1211 (relating to the limitation on capital losses); Are taken into account under section 1231 (relating to property used in a trade or business and involuntary conversions). Free tax programs See Section 1231 Gains and Losses in Publication 544 for more information. Free tax programs Are attributable to pre-enactment interests in activities. Free tax programs See Regulations section 1. Free tax programs 469-11T(c). Free tax programs Grouping Your Activities You can treat one or more trade or business activities, or rental activities, as a single activity if those activities form an appropriate economic unit for measuring gain or loss under the passive activity rules. Free tax programs Grouping is important for a number of reasons. Free tax programs If you group two activities into one larger activity, you need only show material participation in the activity as a whole. Free tax programs But if the two activities are separate, you must show material participation in each one. Free tax programs On the other hand, if you group two activities into one larger activity and you dispose of one of the two, then you have disposed of only part of your entire interest in the activity. Free tax programs But if the two activities are separate and you dispose of one of them, then you have disposed of your entire interest in that activity. Free tax programs Grouping can also be important in determining whether you meet the 10% ownership requirement for actively participating in a rental real estate activity. Free tax programs Appropriate Economic Units Generally, to determine if activities form an appropriate economic unit, you must consider all the relevant facts and circumstances. Free tax programs You can use any reasonable method of applying the relevant facts and circumstances in grouping activities. Free tax programs The following factors have the greatest weight in determining whether activities form an appropriate economic unit. Free tax programs All of the factors do not have to apply to treat more than one activity as a single activity. Free tax programs The factors that you should consider are: The similarities and differences in the types of trades or businesses, The extent of common control, The extent of common ownership, The geographical location, and The interdependencies between or among activities, which may include the extent to which the activities: Buy or sell goods between or among themselves, Involve products or services that are generally provided together, Have the same customers, Have the same employees, or Use a single set of books and records to account for the activities. Free tax programs Example 1. Free tax programs John Jackson owns a bakery and a movie theater at a shopping mall in Baltimore and a bakery and movie theater in Philadelphia. Free tax programs Based on all the relevant facts and circumstances, there may be more than one reasonable method for grouping John's activities. Free tax programs For example, John may be able to group the movie theaters and the bakeries into: One activity, A movie theater activity and a bakery activity, A Baltimore activity and a Philadelphia activity, or Four separate activities. Free tax programs Example 2. Free tax programs Betty is a partner in ABC partnership, which sells nonfood items to grocery stores. Free tax programs Betty is also a partner in DEF (a trucking business). Free tax programs ABC and DEF are under common control. Free tax programs The main part of DEF's business is transporting goods for ABC. Free tax programs DEF is the only trucking business in which Betty is involved. Free tax programs Based on the rules of this section, Betty treats ABC's wholesale activity and DEF's trucking activity as a single activity. Free tax programs Consistency and disclosure requirement. Free tax programs   Generally, when you group activities into appropriate economic units, you may not regroup those activities in a later tax year. Free tax programs You must meet any disclosure requirements of the IRS when you first group your activities and when you add or dispose of any activities in your groupings. Free tax programs   However, if the original grouping is clearly inappropriate or there is a material change in the facts and circumstances that makes the original grouping clearly inappropriate, you must regroup the activities and comply with any disclosure requirements of the IRS. Free tax programs   See Disclosure Requirement , later. Free tax programs Regrouping by the IRS. Free tax programs   If any of the activities resulting from your grouping is not an appropriate economic unit and one of the primary purposes of your grouping (or failure to regroup) is to avoid the passive activity rules, the IRS may regroup your activities. Free tax programs Rental activities. Free tax programs   In general, you cannot group a rental activity with a trade or business activity. Free tax programs However, you can group them together if the activities form an appropriate economic unit and: The rental activity is insubstantial in relation to the trade or business activity, The trade or business activity is insubstantial in relation to the rental activity, or Each owner of the trade or business activity has the same ownership interest in the rental activity, in which case the part of the rental activity that involves the rental of items of property for use in the trade or business activity may be grouped with the trade or business activity. Free tax programs Example. Free tax programs Herbert and Wilma are married and file a joint return. Free tax programs Healthy Food, an S corporation, is a grocery store business. Free tax programs Herbert is Healthy Food's only shareholder. Free tax programs Plum Tower, an S corporation, owns and rents out the building. Free tax programs Wilma is Plum Tower's only shareholder. Free tax programs Plum Tower rents part of its building to Healthy Food. Free tax programs Plum Tower's grocery store rental business and Healthy Food's grocery business are not insubstantial in relation to each other. Free tax programs Herbert and Wilma file a joint return, so they are treated as one taxpayer for purposes of the passive activity rules. Free tax programs The same owner (Herbert and Wilma) owns both Healthy Food and Plum Tower with the same ownership interest (100% in each). Free tax programs If the grouping forms an appropriate economic unit, as discussed earlier, Herbert and Wilma can group Plum Tower's grocery store rental and Healthy Food's grocery business into a single trade or business activity. Free tax programs Grouping of real and personal property rentals. Free tax programs   In general, you cannot treat an activity involving the rental of real property and an activity involving the rental of personal property as a single activity. Free tax programs However, you can treat them as a single activity if you provide the personal property in connection with the real property or the real property in connection with the personal property. Free tax programs Certain activities may not be grouped. Free tax programs   In general, if you own an interest as a limited partner or a limited entrepreneur in one of the following activities, you may not group that activity with any other activity in another type of business. Free tax programs Holding, producing, or distributing motion picture films or video tapes. Free tax programs Farming. Free tax programs Leasing any section 1245 property (as defined in section 1245(a)(3) of the Internal Revenue Code). Free tax programs For a list of section 1245 property, see Section 1245 property under Activities Covered by the At-Risk Rules , later. Free tax programs Exploring for, or exploiting, oil and gas resources. Free tax programs Exploring for, or exploiting, geothermal deposits. Free tax programs   If you own an interest as a limited partner or a limited entrepreneur in an activity described in the list above, you may group that activity with another activity in the same type of business if the grouping forms an appropriate economic unit as discussed earlier. Free tax programs Limited entrepreneur. Free tax programs   A limited entrepreneur is a person who: Has an interest in an enterprise other than as a limited partner, and Does not actively participate in the management of the enterprise. Free tax programs Activities conducted through another entity. Free tax programs   A personal service corporation, closely held corporation, partnership, or S corporation must group its activities using the rules discussed in this section. Free tax programs Once the entity groups its activities, you, as the partner or shareholder of the entity, may group those activities (following the rules of this section): With each other, With activities conducted directly by you, or With activities conducted through other entities. Free tax programs    You may not treat activities grouped together by the entity as separate activities. Free tax programs Personal service and closely held corporations. Free tax programs   You may group an activity conducted through a personal service or closely held corporation with your other activities only to determine whether you materially or significantly participated in those other activities. Free tax programs See Material Participation , earlier, and Significant Participation Passive Activities , later. Free tax programs Publicly traded partnership (PTP). Free tax programs   You may not group activities conducted through a PTP with any other activity, including an activity conducted through another PTP. Free tax programs Partial dispositions. Free tax programs   If you dispose of substantially all of an activity during your tax year, you may treat the part disposed of as a separate activity. Free tax programs However, you can do this only if you can show with reasonable certainty: The amount of deductions and credits disallowed in prior years under the passive activity rules that is allocable to the part of the activity disposed of, and The amount of gross income and any other deductions and credits for the current tax year that is allocable to the part of the activity disposed of. Free tax programs Disclosure Requirement For tax years beginning after January 24, 2010, the following disclosure requirements for groupings apply. Free tax programs You are required to report certain changes to your groupings that occur during the tax year to the IRS. Free tax programs If you fail to report these changes, each trade or business activity or rental activity will be treated as a separate activity. Free tax programs You will be considered to have made a timely disclosure if you filed all affected income tax returns consistent with the claimed grouping and make the required disclosure on the income tax return for the year in which you first discovered the failure to disclose. Free tax programs If the IRS discovered the failure to disclose, you must have reasonable cause for not making the required disclosure. Free tax programs New grouping. Free tax programs   You must file a written statement with your original income tax return for the first tax year in which two or more activities are originally grouped into a single activity. Free tax programs The statement must provide the names, addresses, and employer identification numbers (EINs), if applicable, for the activities being grouped as a single activity. Free tax programs In addition, the statement must contain a declaration that the grouped activities make up an appropriate economic unit for the measurement of gain or loss under the passive activity rules. Free tax programs Addition to an existing grouping. Free tax programs   You must file a written statement with your original income tax return for the tax year in which you add a new activity to an existing group. Free tax programs The statement must provide the name, address, and EIN, if applicable, for the activity that is being added and for the activities in the existing group. Free tax programs In addition, the statement must contain a declaration that the activities make up an appropriate economic unit for the measurement of gain or loss under the passive activity rules. Free tax programs Regrouping. Free tax programs   You must file a written statement with your original income tax return for the tax year in which you regroup the activities. Free tax programs The statement must provide the names, addresses, and EINs, if applicable, for the activities that are being regrouped. Free tax programs If two or more activities are being regrouped into a single activity, the statement must contain a declaration that the regrouped activities make up an appropriate economic unit for the measurement of gain or loss under the passive activity rules. Free tax programs In addition, the statement must contain an explanation of the material change in the facts and circumstances that made the original grouping clearly inappropriate. Free tax programs Groupings by partnerships and S corporations. Free tax programs   Partnerships and S corporations are not subject to the rules for new grouping, addition to an existing grouping, or regrouping. Free tax programs Instead, they must comply with the disclosure instructions for grouping activities provided in their Form 1065, U. Free tax programs S. Free tax programs Return of Partnership Income, or Form 1120S, U. Free tax programs S. Free tax programs Income Tax Return for an S Corporation, whichever is applicable. Free tax programs   The partner or shareholder is not required to make a separate disclosure of the groupings disclosed by the entity unless the partner or shareholder: Groups together any of the activities that the entity does not group together, Groups the entity's activities with activities conducted directly by the partner or shareholder, or Groups an entity's activities with activities conducted through another entity. Free tax programs   A partner or shareholder may not treat activities grouped together by the entity as separate activities. Free tax programs Recharacterization of Passive Income Net income from the following passive activities may have to be recharacterized and excluded from passive activity income. Free tax programs Significant participation passive activities, Rental of property when less than 30% of the unadjusted basis of the property is subject to depreciation, Equity-financed lending activities, Rental of property incidental to development activities, Rental of property to nonpassive activities, and Licensing of intangible property by  pass-through entities. Free tax programs If you are engaged in or have an interest in one of these activities during the tax year (either directly or through a partnership or an S corporation), combine the income and losses from the activity to determine if you have a net loss or net income from that activity. Free tax programs If the result is a net loss, treat the income and losses the same as any other income or losses from that type of passive activity (trade or business activity or rental activity). Free tax programs If the result is net income, do not enter any of the income or losses from the activity or property on Form 8582 or its worksheets. Free tax programs Instead, enter income or losses on the form and schedules you normally use. Free tax programs However, see Significant Participation Passive Activities , later, if the activity is a significant participation passive activity and you also have a net loss from a different significant participation passive activity. Free tax programs Limit on recharacterized passive income. Free tax programs   The total amount that you treat as nonpassive income under the rules described later in this discussion for significant participation passive activities, rental of nondepreciable property, and equity-financed lending activities cannot exceed the greatest amount that you treat as nonpassive income under any one of these rules. Free tax programs Investment income and investment expense. Free tax programs   To figure your investment interest expense limitation on Form 4952, treat as investment income any net passive income recharacterized as nonpassive income from rental of nondepreciable property, equity-financed lending activity, or licensing of intangible property by a pass-through entity. Free tax programs Significant Participation Passive Activities A significant participation passive activity is any trade or business activity in which you participated for more than 100 hours during the tax year but did not materially participate. Free tax programs If your gross income from all significant participation passive activities is more than your deductions from those activities, a part of your net income from each significant participation passive activity is treated as nonpassive income. Free tax programs Corporations. Free tax programs   An activity of a personal service corporation or closely held corporation is a significant participation passive activity if both of the following statements are true. Free tax programs The corporation is not treated as materially participating in the activity for the year. Free tax programs One or more individuals, each of whom is treated as significantly participating in the activity, directly or indirectly hold (in total) more than 50% (by value) of the corporation's outstanding stock. Free tax programs Worksheet A. Free tax programs   Complete Worksheet A. Free tax programs Significant Participation Passive Activities , below, if you have income or losses from any significant participation activity. Free tax programs Begin by entering the name of each activity in the left column. Free tax programs Column (a). Free tax programs   Enter the number of hours you participated in each activity and total the column. Free tax programs   If the total is more than 500, do not complete Worksheet A or B. Free tax programs None of the activities are passive activities because you satisfy test 4 for material participation. Free tax programs (See Material participation tests , earlier. Free tax programs ) Report all the income and losses from these activities on the forms and schedules you normally use. Free tax programs Do not include the income and losses on Form 8582. Free tax programs Column (b). Free tax programs   Enter the net loss, if any, from the activity. Free tax programs Net loss from an activity means either: The activity's current year net loss (if any) plus prior year unallowed losses (if any), or The excess of prior year unallowed losses over the current year net income (if any). Free tax programs Enter -0- here if the prior year unallowed loss is the same as the current year net income. Free tax programs Column (c). Free tax programs   Enter net income (if any) from the activity. Free tax programs Net income means the excess of the current year's net income from the activity over any prior year unallowed losses from the activity. Free tax programs Column (d). Free tax programs   Combine amounts in the Totals row for columns (b) and (c) and enter the total net income or net loss in the Totals row of column (d). Free tax programs If column (d) is a net loss, skip Worksheet B, Significant Participation Activities With Net Income. Free tax programs Include the income and losses in Worksheet 3 of Form 8582 (or Worksheet 2 in the Form 88