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Http www irs gov freefile 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. Http www irs gov freefile Even though the rules do not apply to grantor trusts, partnerships, and S corporations directly, they do apply to the owners of these entities. Http www irs gov freefile 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. Http www irs gov freefile 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. Http www irs gov freefile See Passive Activity Deductions, later. Http www irs gov freefile Passive Activity Loss Generally, the passive activity loss for the tax year is not allowed. Http www irs gov freefile However, there is a special allowance under which some or all of your passive activity loss may be allowed. Http www irs gov freefile See Special $25,000 allowance , later. Http www irs gov freefile Definition of passive activity loss. Http www irs gov freefile    Generally, your passive activity loss for the tax year is the excess of your passive activity deductions over your passive activity gross income. Http www irs gov freefile See Passive Activity Income and Deductions , later. Http www irs gov freefile   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. Http www irs gov freefile For details on net active income, see the Instructions for Form 8810. Http www irs gov freefile For the definition of passive activity gross income, see Passive Activity Income , later. Http www irs gov freefile For the definition of passive activity deductions, see Passive Activity Deductions , later. Http www irs gov freefile 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. Http www irs gov freefile Allocation of disallowed passive activity loss among activities. Http www irs gov freefile   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. Http www irs gov freefile 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. Http www irs gov freefile Use Worksheet 5 of Form 8582 to figure the ratable portion of the loss from each activity that is disallowed. Http www irs gov freefile Loss from an activity. Http www irs gov freefile   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. Http www irs gov freefile   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. Http www irs gov freefile See Significant Participation Passive Activities , later. Http www irs gov freefile Example. Http www irs gov freefile John Pine holds interests in three passive activities, A, B, and C. Http www irs gov freefile 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. Http www irs gov freefile Therefore, a ratable portion of the losses from activities A and B is disallowed. Http www irs gov freefile 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. Http www irs gov freefile   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. Http www irs gov freefile 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. Http www irs gov freefile Excluded deductions. Http www irs gov freefile    “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. Http www irs gov freefile See Recharacterization of Passive Income , later. Http www irs gov freefile Separately identified deductions. Http www irs gov freefile   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. Http www irs gov freefile   Use Form 8582, Worksheet 7, for any activity if you have passive activity deductions for that activity that must be separately identified. Http www irs gov freefile   Deductions that must be accounted for separately include (but are not limited to) the following deductions. Http www irs gov freefile Deductions that arise in a rental real estate activity in tax years in which you actively participate in such activity. Http www irs gov freefile See Active participation , later. Http www irs gov freefile Deductions that arise in a rental real estate activity in tax years in which you do not actively participate in such activity. Http www irs gov freefile See Active participation , later. Http www irs gov freefile Losses from sales or exchanges of capital assets. Http www irs gov freefile Section 1231 losses. Http www irs gov freefile See Section 1231 Gains and Losses in Publication 544, Sales and Other Disposition of Assets, for more information. Http www irs gov freefile 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. Http www irs gov freefile 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. Http www irs gov freefile For more information, see Regulations section 1. Http www irs gov freefile 469-1(f)(4). Http www irs gov freefile Passive Activity Credit Generally, the passive activity credit for the tax year is disallowed. Http www irs gov freefile 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. Http www irs gov freefile Credits that are included in figuring the general business credit are subject to the passive activity rules. Http www irs gov freefile See the Instructions for Form 8582-CR for more information. Http www irs gov freefile 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). Http www irs gov freefile You also must apply the limit on passive activity credits separately to your credits from a passive activity held through a PTP. Http www irs gov freefile You can offset deductions from passive activities of a PTP only against income or gain from passive activities of the same PTP. Http www irs gov freefile Likewise, you can offset credits from passive activities of a PTP only against the tax on the net passive income from the same PTP. Http www irs gov freefile This separate treatment rule also applies to a regulated investment company holding an interest in a PTP for the items attributable to that interest. Http www irs gov freefile 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. Http www irs gov freefile 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. Http www irs gov freefile These rules do not apply to C corporations. Http www irs gov freefile For information, see the Instructions for Schedule F (Form 1040), Profit or Loss From Farming. Http www irs gov freefile Passive Activities There are two kinds of passive activities. Http www irs gov freefile Trade or business activities in which you do not materially participate during the year. Http www irs gov freefile Rental activities, even if you do materially participate in them, unless you are a real estate professional. Http www irs gov freefile Material participation in a trade or business is discussed later, under Activities That Are Not Passive Activities . Http www irs gov freefile Treatment of former passive activities. Http www irs gov freefile   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. Http www irs gov freefile 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. Http www irs gov freefile Treat any remaining prior year unallowed loss like you treat any other passive loss. Http www irs gov freefile   In addition, any prior year unallowed passive activity credits from a former passive activity offset the allocable part of your current year tax liability. Http www irs gov freefile 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. Http www irs gov freefile 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). Http www irs gov freefile 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). Http www irs gov freefile 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. Http www irs gov freefile You generally report trade or business activities on Schedule C, C-EZ, F, or in Part II or III of Schedule E. Http www irs gov freefile 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. Http www irs gov freefile See Real Estate Professional under Activities That Are Not Passive Activities, later. Http www irs gov freefile 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. Http www irs gov freefile It does not matter whether the use is under a lease, a service contract, or some other arrangement. Http www irs gov freefile Exceptions. Http www irs gov freefile   Your activity is not a rental activity if any of the following apply. Http www irs gov freefile The average period of customer use of the property is 7 days or less. Http www irs gov freefile 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. Http www irs gov freefile If the activity involves renting more than one class of property, multiply the average period of customer use of each class by a fraction. Http www irs gov freefile 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. Http www irs gov freefile The activity's average period of customer use will equal the sum of the amounts for each class. Http www irs gov freefile 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. Http www irs gov freefile Significant personal services include only services performed by individuals. Http www irs gov freefile 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. Http www irs gov freefile Significant personal services do not include the following. Http www irs gov freefile 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. Http www irs gov freefile You provide extraordinary personal services in making the rental property available for customer use. Http www irs gov freefile 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. Http www irs gov freefile The rental is incidental to a nonrental activity. Http www irs gov freefile 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. Http www irs gov freefile The unadjusted basis of property is its cost not reduced by depreciation or any other basis adjustment. Http www irs gov freefile The rental of property is incidental to a trade or business activity if all of the following apply. Http www irs gov freefile You own an interest in the trade or business activity during the year. Http www irs gov freefile 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. Http www irs gov freefile Your gross rental income from the property is less than 2% of the smaller of its unadjusted basis or fair market value. Http www irs gov freefile 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. Http www irs gov freefile You customarily make the rental property available during defined business hours for nonexclusive use by various customers. Http www irs gov freefile 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. Http www irs gov freefile    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. Http www irs gov freefile Special $25,000 allowance. Http www irs gov freefile   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. Http www irs gov freefile This special allowance is an exception to the general rule disallowing the passive activity loss. Http www irs gov freefile 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. Http www irs gov freefile   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. Http www irs gov freefile 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. Http www irs gov freefile   The maximum special allowance is reduced if your modified adjusted gross income exceeds certain amounts. Http www irs gov freefile See Phaseout rule , later. Http www irs gov freefile Example. Http www irs gov freefile 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. Http www irs gov freefile She can use $15,000 of her $26,000 loss to offset her $15,000 passive income from the partnership. Http www irs gov freefile 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). Http www irs gov freefile Commercial revitalization deduction (CRD). Http www irs gov freefile   The special allowance must first be applied to losses from rental real estate activities figured without the CRD. Http www irs gov freefile 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. Http www irs gov freefile You cannot claim a CRD for a building placed in service after December 31, 2009. Http www irs gov freefile Active participation. Http www irs gov freefile   Active participation is not the same as material participation (defined later). Http www irs gov freefile Active participation is a less stringent standard than material participation. Http www irs gov freefile For example, you may be treated as actively participating if you make management decisions in a significant and bona fide sense. Http www irs gov freefile Management decisions that count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and similar decisions. Http www irs gov freefile   Only individuals can actively participate in rental real estate activities. Http www irs gov freefile 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. Http www irs gov freefile   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. Http www irs gov freefile 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. Http www irs gov freefile   The choice is irrevocable and cannot be made later than the due date for the estate's first income tax return (including any extensions). Http www irs gov freefile   Limited partners are not treated as actively participating in a partnership's rental real estate activities. Http www irs gov freefile   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. Http www irs gov freefile   Active participation is not required to take the low-income housing credit, the rehabilitation investment credit, or CRD from rental real estate activities. Http www irs gov freefile Example. Http www irs gov freefile 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. Http www irs gov freefile He advertised and rented the house to the current tenant himself. Http www irs gov freefile He also collected the rents and did the repairs or hired someone to do them. Http www irs gov freefile 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. Http www irs gov freefile Phaseout rule. Http www irs gov freefile   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). Http www irs gov freefile 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. Http www irs gov freefile    Modified adjusted gross income for this purpose is your adjusted gross income figured without the following. Http www irs gov freefile Taxable social security and tier 1 railroad retirement benefits. Http www irs gov freefile Deductible contributions to individual retirement accounts (IRAs) and section 501(c)(18) pension plans. Http www irs gov freefile The exclusion from income of interest from qualified U. Http www irs gov freefile S. Http www irs gov freefile savings bonds used to pay qualified higher education expenses. Http www irs gov freefile The exclusion from income of amounts received from an employer's adoption assistance program. Http www irs gov freefile Passive activity income or loss included on Form 8582. Http www irs gov freefile 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). Http www irs gov freefile Any overall loss from a publicly traded partnership (see Publicly Traded Partnerships (PTPs) in the instructions for Form 8582). Http www irs gov freefile The deduction for the employer-equivalent portion of self-employment tax. Http www irs gov freefile The deduction for domestic production activities. Http www irs gov freefile The deduction allowed for interest on student loans. Http www irs gov freefile The deduction for qualified tuition and related expenses. Http www irs gov freefile Example. Http www irs gov freefile During 2013, John was unmarried and was not a real estate professional. Http www irs gov freefile For 2013, he had $120,000 in salary and a $31,000 loss from his rental real estate activities in which he actively participated. Http www irs gov freefile His modified adjusted gross income is $120,000. Http www irs gov freefile When he files his 2013 return, he can deduct only $15,000 of his passive activity loss. Http www irs gov freefile He must carry over the remaining $16,000 passive activity loss to 2014. Http www irs gov freefile 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. Http www irs gov freefile   A higher phaseout range applies to rehabilitation investment credits from rental real estate activities. Http www irs gov freefile 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). Http www irs gov freefile   There is no phaseout of the $25,000 special allowance for low-income housing credits or for the CRD. Http www irs gov freefile Ordering rules. Http www irs gov freefile   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. Http www irs gov freefile The portion of passive activity losses not attributable to the CRD. Http www irs gov freefile The portion of passive activity losses attributable to the CRD. Http www irs gov freefile The portion of passive activity credits attributable to credits other than the rehabilitation and low-income housing credits. Http www irs gov freefile The portion of passive activity credits attributable to the rehabilitation credit. Http www irs gov freefile The portion of passive activity credits attributable to the low-income housing credit. Http www irs gov freefile Activities That Are Not Passive Activities The following are not passive activities. Http www irs gov freefile Trade or business activities in which you materially participated for the tax year. Http www irs gov freefile 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). Http www irs gov freefile It does not matter whether you materially participated in the activity for the tax year. Http www irs gov freefile 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. Http www irs gov freefile  See Temporary Regulations section 1. Http www irs gov freefile 469-1T(e)(4)(ii). Http www irs gov freefile 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. Http www irs gov freefile An activity of trading personal property for the account of those who own interests in the activity. Http www irs gov freefile See Temporary Regulations section 1. Http www irs gov freefile 469-1T(e)(6). Http www irs gov freefile Rental real estate activities in which you materially participated as a real estate professional. Http www irs gov freefile See Real Estate Professional , later. Http www irs gov freefile You should not enter income and losses from these activities on Form 8582. Http www irs gov freefile Instead, enter them on the forms or schedules you would normally use. Http www irs gov freefile Material Participation A trade or business activity is not a passive activity if you materially participated in the activity. Http www irs gov freefile Material participation tests. Http www irs gov freefile    You materially participated in a trade or business activity for a tax year if you satisfy any of the following tests. Http www irs gov freefile You participated in the activity for more than 500 hours. Http www irs gov freefile 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. Http www irs gov freefile 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. Http www irs gov freefile The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. Http www irs gov freefile 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. Http www irs gov freefile See Significant Participation Passive Activities , under Recharacterization of Passive Income, later. Http www irs gov freefile You materially participated in the activity for any 5 (whether or not consecutive) of the 10 immediately preceding tax years. Http www irs gov freefile The activity is a personal service activity in which you materially participated for any 3 (whether or not consecutive) preceding tax years. Http www irs gov freefile 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. Http www irs gov freefile Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the year. Http www irs gov freefile   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. Http www irs gov freefile 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). Http www irs gov freefile Participation. Http www irs gov freefile   In general, any work you do in connection with an activity in which you own an interest is treated as participation in the activity. Http www irs gov freefile Work not usually performed by owners. Http www irs gov freefile   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. Http www irs gov freefile The work is not work that is customarily done by the owner of that type of activity. Http www irs gov freefile 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. Http www irs gov freefile Participation as an investor. Http www irs gov freefile   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. Http www irs gov freefile 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. Http www irs gov freefile Spouse's participation. Http www irs gov freefile   Your participation in an activity includes your spouse's participation. Http www irs gov freefile 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. Http www irs gov freefile Proof of participation. Http www irs gov freefile You can use any reasonable method to prove your participation in an activity for the year. Http www irs gov freefile You do not have to keep contemporaneous daily time reports, logs, or similar documents if you can establish your participation in some other way. Http www irs gov freefile 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. Http www irs gov freefile Limited partners. Http www irs gov freefile   If you owned an activity as a limited partner, you generally are not treated as materially participating in the activity. Http www irs gov freefile 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. Http www irs gov freefile   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). Http www irs gov freefile Retired or disabled farmer and surviving spouse of a farmer. Http www irs gov freefile   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. Http www irs gov freefile 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. Http www irs gov freefile Corporations. Http www irs gov freefile   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. Http www irs gov freefile   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. Http www irs gov freefile See Special exception for qualified corporations under Activities Covered by the At-Risk Rules, later. Http www irs gov freefile Real Estate Professional Generally, rental activities are passive activities even if you materially participated in them. Http www irs gov freefile However, if you qualified as a real estate professional, rental real estate activities in which you materially participated are not passive activities. Http www irs gov freefile 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. Http www irs gov freefile See the Instructions for Schedule E (Form 1040), Supplemental Income and Loss, for information about making this choice. Http www irs gov freefile 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). Http www irs gov freefile 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. Http www irs gov freefile Qualifications. Http www irs gov freefile   You qualified as a real estate professional for the year if you met both of the following requirements. Http www irs gov freefile 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. Http www irs gov freefile You performed more than 750 hours of services during the tax year in real property trades or businesses in which you materially participated. Http www irs gov freefile   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. Http www irs gov freefile 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. Http www irs gov freefile   If you file a joint return, do not count your spouse's personal services to determine whether you met the preceding requirements. Http www irs gov freefile However, you can count your spouse's participation in an activity in determining if you materially participated. Http www irs gov freefile Real property trades or businesses. Http www irs gov freefile   A real property trade or business is a trade or business that does any of the following with real property. Http www irs gov freefile Develops or redevelops it. Http www irs gov freefile Constructs or reconstructs it. Http www irs gov freefile Acquires it. Http www irs gov freefile Converts it. Http www irs gov freefile Rents or leases it. Http www irs gov freefile Operates or manages it. Http www irs gov freefile Brokers it. Http www irs gov freefile Closely held corporations. Http www irs gov freefile   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. Http www irs gov freefile 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. Http www irs gov freefile Self-charged interest. Http www irs gov freefile   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. Http www irs gov freefile   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. Http www irs gov freefile This includes both loans you made to the partnership or S corporation and loans the partnership or S corporation made to you. Http www irs gov freefile   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. Http www irs gov freefile    Exception. Http www irs gov freefile 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. Http www irs gov freefile 469-7(g) to avoid the application of these rules. Http www irs gov freefile For more details on the self-charged interest rules, see Regulations section 1. Http www irs gov freefile 469-7. Http www irs gov freefile 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. Http www irs gov freefile Passive activity income does not include the following items. Http www irs gov freefile Income from an activity that is not a passive activity. Http www irs gov freefile These activities are discussed under Activities That Are Not Passive Activities , earlier. Http www irs gov freefile Portfolio income. Http www irs gov freefile This includes interest, dividends, annuities, and royalties not derived in the ordinary course of a trade or business. Http www irs gov freefile It includes gain or loss from the disposition of property that produces these types of income or that is held for investment. Http www irs gov freefile The exclusion for portfolio income does not apply to self-charged interest treated as passive activity income. Http www irs gov freefile For more information on self-charged interest, see Self-charged interest , earlier. Http www irs gov freefile Personal service income. Http www irs gov freefile 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. Http www irs gov freefile Income from positive section 481 adjustments allocated to activities other than passive activities. Http www irs gov freefile (Section 481 adjustments are adjustments that must be made due to changes in your accounting method. Http www irs gov freefile ) Income or gain from investments of working capital. Http www irs gov freefile 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. Http www irs gov freefile 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. Http www irs gov freefile 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. Http www irs gov freefile Any other income that must be treated as nonpassive income. Http www irs gov freefile See Recharacterization of Passive Income , later. Http www irs gov freefile Overall gain from any interest in a publicly traded partnership. Http www irs gov freefile See Publicly Traded Partnerships (PTPs) in the instructions for Form 8582. Http www irs gov freefile State, local, and foreign income tax refunds. Http www irs gov freefile Income from a covenant not to compete. Http www irs gov freefile 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. Http www irs gov freefile Alaska Permanent Fund dividends. Http www irs gov freefile 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. Http www irs gov freefile See chapter 4 of Publication 535, Business Expenses, for information about the rules for allocating interest. Http www irs gov freefile Disposition of property interests. Http www irs gov freefile   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. Http www irs gov freefile 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. Http www irs gov freefile An exception to this general rule may apply if you previously used the property in a different activity. Http www irs gov freefile Exception for more than one use in the preceding 12 months. Http www irs gov freefile   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. Http www irs gov freefile Any gain allocated to a passive activity is passive activity income. Http www irs gov freefile   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. Http www irs gov freefile Exception for substantially appreciated property. Http www irs gov freefile   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. Http www irs gov freefile You used the property in a passive activity for 20% of the time you held your interest in the property. Http www irs gov freefile You used the property in a passive activity for the entire 24-month period before its disposition. Http www irs gov freefile If neither condition applies, the gain is not passive activity income. Http www irs gov freefile 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. Http www irs gov freefile   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. Http www irs gov freefile Also, treat the date you agree to transfer your interest for a fixed or determinable amount as the disposition date. Http www irs gov freefile   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. Http www irs gov freefile Disposition of property converted to inventory. Http www irs gov freefile   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. Http www irs gov freefile 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. Http www irs gov freefile This rule applies only if you meet all of the following conditions. Http www irs gov freefile 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). Http www irs gov freefile 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. Http www irs gov freefile 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. Http www irs gov freefile 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. Http www irs gov freefile 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. Http www irs gov freefile See Coordination with other limitations on deductions that apply before the passive activity rules , later. Http www irs gov freefile 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. Http www irs gov freefile Exceptions. Http www irs gov freefile   Passive activity deductions do not include the following items. Http www irs gov freefile Deductions for expenses (other than interest expense) that are clearly and directly allocable to portfolio income. Http www irs gov freefile Qualified home mortgage interest, capitalized interest expenses, and other interest expenses (other than self-charged interest) properly allocable to passive activities. Http www irs gov freefile For more information on self-charged interest, see Self-charged interest under Passive Activity Income and Deductions, earlier. Http www irs gov freefile Losses from dispositions of property that produce portfolio income or property held for investment. Http www irs gov freefile State, local, and foreign income taxes. Http www irs gov freefile Miscellaneous itemized deductions that may be disallowed because of the 2%-of-adjusted-gross-income limit. Http www irs gov freefile Charitable contribution deductions. Http www irs gov freefile Net operating loss deductions. Http www irs gov freefile Percentage depletion carryovers for oil and gas wells. Http www irs gov freefile Capital loss carrybacks and carryovers. Http www irs gov freefile Items of deduction from a passive activity that are disallowed under the limits on deductions that apply before the passive activity rules. Http www irs gov freefile See Coordination with other limitations on deductions that apply before the passive activity rules , later. Http www irs gov freefile Deductions and losses that would have been allowed for tax years beginning before 1987 but for basis or at-risk limits. Http www irs gov freefile Net negative section 481 adjustments allocated to activities other than passive activities. Http www irs gov freefile (Section 481 adjustments are adjustments required due to changes in accounting methods. Http www irs gov freefile ) Casualty and theft losses, unless losses similar in cause and severity recur regularly in the activity. Http www irs gov freefile The deduction for the employer-equivalent portion of self-employment tax. Http www irs gov freefile Coordination with other limitations on deductions that apply before the passive activity rules. Http www irs gov freefile   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. Http www irs gov freefile 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. Http www irs gov freefile Proration of deductions disallowed under basis limitations. Http www irs gov freefile   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. Http www irs gov freefile 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. Http www irs gov freefile   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. Http www irs gov freefile 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. Http www irs gov freefile Proration of deductions disallowed under at-risk limitation. Http www irs gov freefile   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. Http www irs gov freefile 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. Http www irs gov freefile Coordination of basis and at-risk limitations. Http www irs gov freefile   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. Http www irs gov freefile Separately identified items of deduction and loss. Http www irs gov freefile   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. Http www irs gov freefile   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. Http www irs gov freefile See Grouping Your Activities , later. Http www irs gov freefile 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). Http www irs gov freefile See Section 1231 Gains and Losses in Publication 544 for more information. Http www irs gov freefile Are attributable to pre-enactment interests in activities. Http www irs gov freefile See Regulations section 1. Http www irs gov freefile 469-11T(c). Http www irs gov freefile 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. Http www irs gov freefile Grouping is important for a number of reasons. Http www irs gov freefile If you group two activities into one larger activity, you need only show material participation in the activity as a whole. Http www irs gov freefile But if the two activities are separate, you must show material participation in each one. Http www irs gov freefile 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. Http www irs gov freefile 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. Http www irs gov freefile Grouping can also be important in determining whether you meet the 10% ownership requirement for actively participating in a rental real estate activity. Http www irs gov freefile Appropriate Economic Units Generally, to determine if activities form an appropriate economic unit, you must consider all the relevant facts and circumstances. Http www irs gov freefile You can use any reasonable method of applying the relevant facts and circumstances in grouping activities. Http www irs gov freefile The following factors have the greatest weight in determining whether activities form an appropriate economic unit. Http www irs gov freefile All of the factors do not have to apply to treat more than one activity as a single activity. Http www irs gov freefile 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. Http www irs gov freefile Example 1. Http www irs gov freefile John Jackson owns a bakery and a movie theater at a shopping mall in Baltimore and a bakery and movie theater in Philadelphia. Http www irs gov freefile Based on all the relevant facts and circumstances, there may be more than one reasonable method for grouping John's activities. Http www irs gov freefile 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. Http www irs gov freefile Example 2. Http www irs gov freefile Betty is a partner in ABC partnership, which sells nonfood items to grocery stores. Http www irs gov freefile Betty is also a partner in DEF (a trucking business). Http www irs gov freefile ABC and DEF are under common control. Http www irs gov freefile The main part of DEF's business is transporting goods for ABC. Http www irs gov freefile DEF is the only trucking business in which Betty is involved. Http www irs gov freefile Based on the rules of this section, Betty treats ABC's wholesale activity and DEF's trucking activity as a single activity. Http www irs gov freefile Consistency and disclosure requirement. Http www irs gov freefile   Generally, when you group activities into appropriate economic units, you may not regroup those activities in a later tax year. Http www irs gov freefile 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. Http www irs gov freefile   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. Http www irs gov freefile   See Disclosure Requirement , later. Http www irs gov freefile Regrouping by the IRS. Http www irs gov freefile   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. Http www irs gov freefile Rental activities. Http www irs gov freefile   In general, you cannot group a rental activity with a trade or business activity. Http www irs gov freefile 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. Http www irs gov freefile Example. Http www irs gov freefile Herbert and Wilma are married and file a joint return. Http www irs gov freefile Healthy Food, an S corporation, is a grocery store business. Http www irs gov freefile Herbert is Healthy Food's only shareholder. Http www irs gov freefile Plum Tower, an S corporation, owns and rents out the building. Http www irs gov freefile Wilma is Plum Tower's only shareholder. Http www irs gov freefile Plum Tower rents part of its building to Healthy Food. Http www irs gov freefile Plum Tower's grocery store rental business and Healthy Food's grocery business are not insubstantial in relation to each other. Http www irs gov freefile Herbert and Wilma file a joint return, so they are treated as one taxpayer for purposes of the passive activity rules. Http www irs gov freefile The same owner (Herbert and Wilma) owns both Healthy Food and Plum Tower with the same ownership interest (100% in each). Http www irs gov freefile 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. Http www irs gov freefile Grouping of real and personal property rentals. Http www irs gov freefile   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. Http www irs gov freefile 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. Http www irs gov freefile Certain activities may not be grouped. Http www irs gov freefile   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. Http www irs gov freefile Holding, producing, or distributing motion picture films or video tapes. Http www irs gov freefile Farming. Http www irs gov freefile Leasing any section 1245 property (as defined in section 1245(a)(3) of the Internal Revenue Code). Http www irs gov freefile For a list of section 1245 property, see Section 1245 property under Activities Covered by the At-Risk Rules , later. Http www irs gov freefile Exploring for, or exploiting, oil and gas resources. Http www irs gov freefile Exploring for, or exploiting, geothermal deposits. Http www irs gov freefile   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. Http www irs gov freefile Limited entrepreneur. Http www irs gov freefile   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. Http www irs gov freefile Activities conducted through another entity. Http www irs gov freefile   A personal service corporation, closely held corporation, partnership, or S corporation must group its activities using the rules discussed in this section. Http www irs gov freefile 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. Http www irs gov freefile    You may not treat activities grouped together by the entity as separate activities. Http www irs gov freefile Personal service and closely held corporations. Http www irs gov freefile   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. Http www irs gov freefile See Material Participation , earlier, and Significant Participation Passive Activities , later. Http www irs gov freefile Publicly traded partnership (PTP). Http www irs gov freefile   You may not group activities conducted through a PTP with any other activity, including an activity conducted through another PTP. Http www irs gov freefile Partial dispositions. Http www irs gov freefile   If you dispose of substantially all of an activity during your tax year, you may treat the part disposed of as a separate activity. Http www irs gov freefile 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. Http www irs gov freefile Disclosure Requirement For tax years beginning after January 24, 2010, the following disclosure requirements for groupings apply. Http www irs gov freefile You are required to report certain changes to your groupings that occur during the tax year to the IRS. Http www irs gov freefile If you fail to report these changes, each trade or business activity or rental activity will be treated as a separate activity. Http www irs gov freefile 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. Http www irs gov freefile If the IRS discovered the failure to disclose, you must have reasonable cause for not making the required disclosure. Http www irs gov freefile New grouping. Http www irs gov freefile   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. Http www irs gov freefile The statement must provide the names, addresses, and employer identification numbers (EINs), if applicable, for the activities being grouped as a single activity. Http www irs gov freefile 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. Http www irs gov freefile Addition to an existing grouping. Http www irs gov freefile   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. Http www irs gov freefile 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. Http www irs gov freefile 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. Http www irs gov freefile Regrouping. Http www irs gov freefile   You must file a written statement with your original income tax return for the tax year in which you regroup the activities. Http www irs gov freefile The statement must provide the names, addresses, and EINs, if applicable, for the activities that are being regrouped. Http www irs gov freefile 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. Http www irs gov freefile In addition, the statement must contain an explanation of the material change in the facts and circumstances that made the original grouping clearly inappropriate. Http www irs gov freefile Groupings by partnerships and S corporations. Http www irs gov freefile   Partnerships and S corporations are not subject to the rules for new grouping, addition to an existing grouping, or regrouping. Http www irs gov freefile Instead, they must comply with the disclosure instructions for grouping activities provided in their Form 1065, U. Http www irs gov freefile S. Http www irs gov freefile Return of Partnership Income, or Form 1120S, U. Http www irs gov freefile S. Http www irs gov freefile Income Tax Return for an S Corporation, whichever is applicable. Http www irs gov freefile   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. Http www irs gov freefile   A partner or shareholder may not treat activities grouped together by the entity as separate activities. Http www irs gov freefile Recharacterization of Passive Income Net income from the following passive activities may have to be recharacterized and excluded from passive activity income. Http www irs gov freefile 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. Http www irs gov freefile 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. Http www irs gov freefile 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). Http www irs gov freefile 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. Http www irs gov freefile Instead, enter income or losses on the form and schedules you normally use. Http www irs gov freefile 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. Http www irs gov freefile Limit on recharacterized passive income. Http www irs gov freefile   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. Http www irs gov freefile Investment income and investment expense. Http www irs gov freefile   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. Http www irs gov freefile 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. Http www irs gov freefile 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. Http www irs gov freefile Corporations. Http www irs gov freefile   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. Http www irs gov freefile The corporation is not treated as materially participating in the activity for the year. Http www irs gov freefile 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. Http www irs gov freefile Worksheet A. Http www irs gov freefile   Complete Worksheet A. Http www irs gov freefile Significant Participation Passive Activities , below, if you have income or losses from any significant participation activity. Http www irs gov freefile Begin by entering the name of each activity in the left column. Http www irs gov freefile Column (a). Http www irs gov freefile   Enter the number of hours you participated in each activity and total the column. Http www irs gov freefile   If the total is more than 500, do not complete Worksheet A or B. Http www irs gov freefile None of the activities are passive activities because you satisfy test 4 for material participation. Http www irs gov freefile (See Material participation tests , earlier. Http www irs gov freefile ) Report all the income and losses from these activities on the forms and schedules you normally use. Http www irs gov freefile Do not include the income and losses on Form 8582. Http www irs gov freefile Column (b). Http www irs gov freefile   Enter the net loss, if any, from the activity. Http www irs gov freefile 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). Http www irs gov freefile Enter -0- here if the prior year unallowed loss is the same as the current year net income. Http www irs gov freefile Column (c). Http www irs gov freefile   Enter net income (if any) from the activity. Http www irs gov freefile Net income means the excess of the current year's net income from the activity over any prior year unallowed losses from the activity. Http www irs gov freefile Column (d). Http www irs gov freefile   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). Http www irs gov freefile If column (d) is a net loss, skip Worksheet B, Significant Participation Activities With Net Income. Http www irs gov freefile Include the income and losses in Worksheet 3 of Form 8582 (or Worksheet 2 in the Form 88
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Understanding Your CP156 Notice

We received your Form 990-T, Exempt Organization Business Income Tax Return and Form 8941, Credit for Small Employer Health Premiums


However, we reduced your credit based on the following:


In accordance with the requirements of the Balanced Budget and Emergency Deficit Control Act of 1985, as amended, certain automatic reductions take place as of March 1, 2013.


These required reductions include a reduction to the refundable portion of the Small Business Health Care Tax Credit for certain small tax-exempt employers under Internal Revenue Code Section 45R.


As a result, the refundable portion of your claim will be reduced 8.7% percent. The sequestration reduction rate will be applied until the end of the fiscal year (September 30, 2013), or intervening Congressional action, at which time the sequestration rate is subject to change.
 


What you need to do

  • No action is required

  • Answers to Common Questions

    Can I appeal the decision to reduce my refund?
    Reduction in the amount of your refund is required of the Balanced Budget and Emergency Deficit Control Act of 1985, as amended and can't be appealed.

Page Last Reviewed or Updated: 26-Mar-2014

Printable samples of this notice (PDF)

 

 

How to get help

  • Call the 1-800 number listed on the top right corner of your notice.
  • Authorize someone (e.g., accountant) to contact the IRS on your behalf using Form 2848.
  • See if you qualify for help from a Low Income Taxpayer Clinic.
     

The Http Www Irs Gov Freefile

Http www irs gov freefile 1. Http www irs gov freefile   Importance of Records Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Benefits of Recordkeeping Kinds of Records To Keep How Long To Keep Records Introduction A farmer, like other taxpayers, must keep records to prepare an accurate income tax return and determine the correct amount of tax. Http www irs gov freefile This chapter explains the benefits of keeping records, what kinds of records you must keep, and how long you must keep them for federal tax purposes. Http www irs gov freefile Tax records are not the only type of records you need to keep for your farming business. Http www irs gov freefile You should also keep records that measure your farm's financial performance. Http www irs gov freefile This publication only discusses tax records. Http www irs gov freefile The Farm Financial Standards Council has produced a publication that provides a detailed explanation of the recommendations of the Council for financial reporting and analysis. Http www irs gov freefile For information on recordkeeping, you can purchase and download Financial Guidelines for Agricultural Producers at www. Http www irs gov freefile ffsc. Http www irs gov freefile org. Http www irs gov freefile For more information, contact Countryside Marketing, Inc. Http www irs gov freefile in the following manner. Http www irs gov freefile Call 262-253-6902. Http www irs gov freefile Send a fax to 262-253-6903. Http www irs gov freefile Write to: Farm Financial Standards Council N78 W14573 Appleton Ave. Http www irs gov freefile , #287 Menomonee Falls, WI 53051. Http www irs gov freefile Topics - This chapter discusses: Benefits of recordkeeping Kinds of records to keep How long to keep records Useful Items - You may want to see: Publication 51 (Circular A), Agricultural Employer's Tax Guide 463 Travel, Entertainment, Gift, and Car Expenses See chapter 16 for information about getting publications. Http www irs gov freefile Benefits of Recordkeeping Everyone in business, including farmers, must keep appropriate records. Http www irs gov freefile Recordkeeping will help you do the following. Http www irs gov freefile Monitor the progress of your farming business. Http www irs gov freefile   You need records to monitor the progress of your farming business. Http www irs gov freefile Records can show whether your business is improving, which items are selling, or what changes you need to make. Http www irs gov freefile Records can help you make better decisions that may increase the likelihood of business success. Http www irs gov freefile Prepare your financial statements. Http www irs gov freefile   You need records to prepare accurate financial statements. Http www irs gov freefile These include income (profit and loss) statements and balance sheets. Http www irs gov freefile These statements can help you in dealing with your bank or creditors and help you to manage your farm business. Http www irs gov freefile Identify source of receipts. Http www irs gov freefile   You will receive money or property from many sources. Http www irs gov freefile Your records can identify the source of your receipts. Http www irs gov freefile You need this information to separate farm from nonfarm receipts and taxable from nontaxable income. Http www irs gov freefile Keep track of deductible expenses. Http www irs gov freefile   You may forget expenses when you prepare your tax return unless you record them when they occur. Http www irs gov freefile Prepare your tax returns. Http www irs gov freefile   You need records to prepare your tax return. Http www irs gov freefile For example, your records must support the income, expenses, and credits you report. Http www irs gov freefile Generally, these are the same records you use to monitor your farming business and prepare your financial statements. Http www irs gov freefile Support items reported on tax returns. Http www irs gov freefile   You must keep your business records available at all times for inspection by the IRS. Http www irs gov freefile If the IRS examines any of your tax returns, you may be asked to explain the items reported. Http www irs gov freefile A complete set of records will speed up the examination. Http www irs gov freefile Kinds of Records To Keep Except in a few cases, the law does not require any specific kind of records. Http www irs gov freefile You can choose any recordkeeping system suited to your farming business that clearly shows, for example, your income and expenses. Http www irs gov freefile You should set up your recordkeeping system using an accounting method that clearly shows your income for your tax year. Http www irs gov freefile See  chapter 2. Http www irs gov freefile If you are in more than one business, you should keep a complete and separate set of records for each business. Http www irs gov freefile A corporation should keep minutes of board of directors' meetings. Http www irs gov freefile Your recordkeeping system should include a summary of your business transactions. Http www irs gov freefile This summary is ordinarily made in accounting journals and ledgers. Http www irs gov freefile For example, they must show your gross income, as well as your deductions and credits. Http www irs gov freefile In addition, you must keep supporting documents. Http www irs gov freefile Purchases, sales, payroll, and other transactions you have in your business generate supporting documents such as invoices and receipts. Http www irs gov freefile These documents contain the information you need to record in your journals and ledgers. Http www irs gov freefile It is important to keep these documents because they support the entries in your journals and ledgers and on your tax return. Http www irs gov freefile Keep them in an orderly fashion and in a safe place. Http www irs gov freefile For instance, organize them by year and type of income or expense. Http www irs gov freefile Electronic records. Http www irs gov freefile   All requirements that apply to hard copy books and records also apply to electronic storage systems that maintain tax books and records. Http www irs gov freefile When you replace hard copy books and records, you must maintain the electronic storage systems for as long as they are material to the administration of tax law. Http www irs gov freefile An electronic storage system is any system for preparing or keeping your records either by electronic imaging or by transfer to an electronic storage media. Http www irs gov freefile The electronic storage system must index, store, preserve, retrieve and reproduce the electronically stored books and records in legible format. Http www irs gov freefile All electronic storage systems must provide a complete and accurate record of your data that is accessible to the IRS. Http www irs gov freefile Electronic storage systems are also subject to the same controls and retention guidelines as those imposed on your original hard copy books and records. Http www irs gov freefile The original hard copy books and records may be destroyed provided that the electronic storage system has been tested to establish that the hard copy books and records are being reproduced in compliance with IRS requirements for an electronic storage system and procedures are established to ensure continued compliance with all applicable rules and regulations. Http www irs gov freefile You still have the responsibility of retaining any other books and records that are required to be retained. Http www irs gov freefile The IRS may test your electronic storage system, including the equipment used, indexing methodology, software and retrieval capabilities. Http www irs gov freefile This test is not considered an examination and the results must be shared with you. Http www irs gov freefile If your electronic storage system meets the requirements mentioned earlier, you will be in compliance. Http www irs gov freefile If not, you may be subject to penalties for non-compliance, unless you continue to maintain your original hard copybooks and records in a manner that allows you and the IRS to determine your correct tax. Http www irs gov freefile For details on electronic storage system requirements, see Rev. Http www irs gov freefile Proc. Http www irs gov freefile 97-22. Http www irs gov freefile You can find Rev. Http www irs gov freefile Proc. Http www irs gov freefile 97-22 on page 9 of Internal Revenue Bulletin 1997-13 at  www. Http www irs gov freefile irs. Http www irs gov freefile gov/pub/irs-irbs/irb97-13. Http www irs gov freefile pdf. Http www irs gov freefile Travel, transportation, entertainment, and gift expenses. Http www irs gov freefile   Specific recordkeeping rules apply to these expenses. Http www irs gov freefile For more information, see Publication 463. Http www irs gov freefile Employment taxes. Http www irs gov freefile   There are specific employment tax records you must keep. Http www irs gov freefile For a list, see Publication 51 (Circular A). Http www irs gov freefile Excise taxes. Http www irs gov freefile   See How To Claim a Credit or Refund in chapter 14 for the specific records you must keep to verify your claim for credit or refund of excise taxes on certain fuels. Http www irs gov freefile Assets. Http www irs gov freefile   Assets are the property, such as machinery and equipment, you own and use in your business. Http www irs gov freefile You must keep records to verify certain information about your business assets. Http www irs gov freefile You need records to figure your annual depreciation deduction and the gain or (loss) when you sell the assets. Http www irs gov freefile Your records should show all the following. Http www irs gov freefile When and how you acquired the asset. Http www irs gov freefile Purchase price. Http www irs gov freefile Cost of any improvements. Http www irs gov freefile Section 179 deduction taken. Http www irs gov freefile Deductions taken for depreciation. Http www irs gov freefile Deductions taken for casualty losses, such as losses resulting from fires or storms. Http www irs gov freefile How you used the asset. Http www irs gov freefile When and how you disposed of the asset. Http www irs gov freefile Selling price. Http www irs gov freefile Expenses of sale. Http www irs gov freefile   The following are examples of records that may show this information. Http www irs gov freefile Purchase and sales invoices. Http www irs gov freefile Real estate closing statements. Http www irs gov freefile Canceled checks. Http www irs gov freefile Bank statements. Http www irs gov freefile Financial account statements as proof of payment. Http www irs gov freefile   If you do not have a canceled check, you may be able to prove payment with certain financial account statements prepared by financial institutions. Http www irs gov freefile These include account statements prepared for the financial institution by a third party. Http www irs gov freefile These account statements must be legible. Http www irs gov freefile The following table lists acceptable account statements. Http www irs gov freefile IF payment is by. Http www irs gov freefile . Http www irs gov freefile . Http www irs gov freefile THEN the statement must show the. Http www irs gov freefile . Http www irs gov freefile . Http www irs gov freefile Check Check number. Http www irs gov freefile Amount. Http www irs gov freefile Payee's name. Http www irs gov freefile Date the check amount was posted to the account by the financial institution. Http www irs gov freefile Electronic funds  transfer Amount transferred. Http www irs gov freefile Payee's name. Http www irs gov freefile Date the transfer was posted to the account by the financial institution. Http www irs gov freefile Credit card Amount charged. Http www irs gov freefile Payee's name. Http www irs gov freefile Transaction date. Http www irs gov freefile    Proof of payment of an amount, by itself, does not establish you are entitled to a tax deduction. Http www irs gov freefile You should also keep other documents, such as credit card sales slips and invoices, to show that you also incurred the cost. Http www irs gov freefile Tax returns. Http www irs gov freefile   Keep copies of your filed tax returns. Http www irs gov freefile They help in preparing future tax returns and making computations if you file an amended return. Http www irs gov freefile Keep copies of your information returns such as Form 1099, Schedule K-1, and Form W-2. Http www irs gov freefile How Long To Keep Records You must keep your records as long as they may be needed for the administration of any provision of the Internal Revenue Code. Http www irs gov freefile Keep records that support an item of income or a deduction appearing on a return until the period of limitations for the return runs out. Http www irs gov freefile A period of limitations is the period of time after which no legal action can be brought. Http www irs gov freefile Generally, that means you must keep your records for at least 3 years from when your tax return was due or filed or within 2 years of the date the tax was paid, whichever is later. Http www irs gov freefile However, certain records must be kept for a longer period of time, as discussed below. Http www irs gov freefile Employment taxes. Http www irs gov freefile   If you have employees, you must keep all employment tax records for at least 4 years after the date the tax becomes due or is paid, whichever is later. Http www irs gov freefile Assets. Http www irs gov freefile   Keep records relating to property until the period of limitations expires for the year in which you dispose of the property in a taxable disposition. Http www irs gov freefile You must keep these records to figure any depreciation, amortization, or depletion deduction and to figure your basis for computing gain or (loss) when you sell or otherwise dispose of the property. Http www irs gov freefile   You may need to keep records relating to the basis of property longer than the period of limitation. Http www irs gov freefile Keep those records as long as they are important in figuring the basis of the original or replacement property. Http www irs gov freefile Generally, this means as long as you own the property and, after you dispose of it, for the period of limitations that applies to you. Http www irs gov freefile For example, if you received property in a nontaxable exchange, you must keep the records for the old property, as well as for the new property, until the period of limitations expires for the year in which you dispose of the new property in a taxable disposition. Http www irs gov freefile For more information on basis, see chapter 6. Http www irs gov freefile Records for nontax purposes. Http www irs gov freefile   When your records are no longer needed for tax purposes, do not discard them until you check to see if you have to keep them longer for other purposes. Http www irs gov freefile For example, your insurance company or creditors may require you to keep them longer than the IRS does. Http www irs gov freefile Prev  Up  Next   Home   More Online Publications