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Irs1040

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Irs1040

Irs1040 2. Irs1040   Employees' Pay Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Tests for Deducting PayTest 1—Reasonableness Test 2—For Services Performed Kinds of PayAwards Bonuses Education Expenses Fringe Benefits Loans or Advances Property Reimbursements for Business Expenses Sick and Vacation Pay Introduction You can generally deduct the amount you pay your employees for the services they perform. Irs1040 The pay may be in cash, property, or services. Irs1040 It may include wages, salaries, bonuses, commissions, or other non-cash compensation such as vacation allowances and fringe benefits. Irs1040 For information about deducting employment taxes, see chapter 5. Irs1040 You can claim employment credits, such as the following, if you hire individuals who meet certain requirements. Irs1040 Empowerment zone employment credit (Form 8844). Irs1040 Indian employment credit (Form 8845). Irs1040 Work opportunity credit (Form 5884). Irs1040 Credit for employer differential wage payments (Form 8932). Irs1040 Reduce your deduction for employee wages by the amount of employment credits you claim. Irs1040 For more information about these credits, see the form on which the credit is claimed. Irs1040 Topics - This chapter discusses: Tests for deducting pay Kinds of pay Useful Items - You may want to see: Publication 15 (Circular E), Employer's Tax Guide 15-A Employer's Supplemental Tax Guide 15-B Employer's Tax Guide to Fringe Benefits See chapter 12 for information about getting publications and forms. Irs1040 Tests for Deducting Pay To be deductible, your employees' pay must be an ordinary and necessary business expense and you must pay or incur it. Irs1040 These and other requirements that apply to all business expenses are explained in chapter 1. Irs1040 In addition, the pay must meet both of the following tests. Irs1040 Test 1. Irs1040 It must be reasonable. Irs1040 Test 2. Irs1040 It must be for services performed. Irs1040 The form or method of figuring the pay does not affect its deductibility. Irs1040 For example, bonuses and commissions based on sales or earnings, and paid under an agreement made before the services were performed, are both deductible. Irs1040 Test 1—Reasonableness You must be able to prove that the pay is reasonable. Irs1040 Whether the pay is reasonable depends on the circumstances that existed when you contracted for the services, not those that exist when reasonableness is questioned. Irs1040 If the pay is excessive, the excess pay is disallowed as a deduction. Irs1040 Factors to consider. Irs1040   Determine the reasonableness of pay by the facts and circumstances. Irs1040 Generally, reasonable pay is the amount that a similar business would pay for the same or similar services. Irs1040   To determine if pay is reasonable, also consider the following items and any other pertinent facts. Irs1040 The duties performed by the employee. Irs1040 The volume of business handled. Irs1040 The character and amount of responsibility. Irs1040 The complexities of your business. Irs1040 The amount of time required. Irs1040 The cost of living in the locality. Irs1040 The ability and achievements of the individual employee performing the service. Irs1040 The pay compared with the gross and net income of the business, as well as with distributions to shareholders if the business is a corporation. Irs1040 Your policy regarding pay for all your employees. Irs1040 The history of pay for each employee. Irs1040 Test 2—For Services Performed You must be able to prove the payment was made for services actually performed. Irs1040 Employee-shareholder salaries. Irs1040   If a corporation pays an employee who is also a shareholder a salary that is unreasonably high considering the services actually performed, the excessive part of the salary may be treated as a constructive dividend to the employee-shareholder. Irs1040 The excessive part of the salary would not be allowed as a salary deduction by the corporation. Irs1040 For more information on corporate distributions to shareholders, see Publication 542, Corporations. Irs1040 Kinds of Pay Some of the ways you may provide pay to your employees in addition to regular wages or salaries are discussed next. Irs1040 For specialized and detailed information on employees' pay and the employment tax treatment of employees' pay, see Publications 15, 15-A, and 15-B. Irs1040 Awards You can generally deduct amounts you pay to your employees as awards, whether paid in cash or property. Irs1040 If you give property to an employee as an employee achievement award, your deduction may be limited. Irs1040 Achievement awards. Irs1040   An achievement award is an item of tangible personal property that meets all the following requirements. Irs1040 It is given to an employee for length of service or safety achievement. Irs1040 It is awarded as part of a meaningful presentation. Irs1040 It is awarded under conditions and circumstances that do not create a significant likelihood of disguised pay. Irs1040 Length-of-service award. Irs1040    An award will qualify as a length-of-service award only if either of the following applies. Irs1040 The employee receives the award after his or her first 5 years of employment. Irs1040 The employee did not receive another length-of-service award (other than one of very small value) during the same year or in any of the prior 4 years. Irs1040 Safety achievement award. Irs1040    An award for safety achievement will qualify as an achievement award unless one of the following applies. Irs1040 It is given to a manager, administrator, clerical employee, or other professional employee. Irs1040 During the tax year, more than 10% of your employees, excluding those listed in (1), have already received a safety achievement award (other than one of very small value). Irs1040 Deduction limit. Irs1040   Your deduction for the cost of employee achievement awards given to any one employee during the tax year is limited to the following. Irs1040 $400 for awards that are not qualified plan awards. Irs1040 $1,600 for all awards, whether or not qualified plan awards. Irs1040   A qualified plan award is an achievement award given as part of an established written plan or program that does not favor highly compensated employees as to eligibility or benefits. Irs1040   A highly compensated employee is an employee who meets either of the following tests. Irs1040 The employee was a 5% owner at any time during the year or the preceding year. Irs1040 The employee received more than $115,000 in pay for the preceding year. Irs1040 You can choose to ignore test (2) if the employee was not also in the top 20% of employees ranked by pay for the preceding year. Irs1040   An award is not a qualified plan award if the average cost of all the employee achievement awards given during the tax year (that would be qualified plan awards except for this limit) is more than $400. Irs1040 To figure this average cost, ignore awards of nominal value. Irs1040 Deduct achievement awards as a nonwage business expense on your return or business schedule. Irs1040 You may not owe employment taxes on the value of some achievement awards you provide to an employee. Irs1040 See Publication 15-B. Irs1040 Bonuses You can generally deduct a bonus paid to an employee if you intended the bonus as additional pay for services, not as a gift, and the services were performed. Irs1040 However, the total bonuses, salaries, and other pay must be reasonable for the services performed. Irs1040 If the bonus is paid in property, see Property , later. Irs1040 Gifts of nominal value. Irs1040    If, to promote employee goodwill, you distribute food or merchandise of nominal value to your employees at holidays, you can deduct the cost of these items as a nonwage business expense. Irs1040 Your deduction for de minimis gifts of food or drink are not subject to the 50% deduction limit that generally applies to meals. Irs1040 For more information on this deduction limit, see Meals and lodging , later. Irs1040 Education Expenses If you pay or reimburse education expenses for an employee, you can deduct the payments if they are part of a qualified educational assistance program. Irs1040 Deduct them on the “Employee benefit programs” or other appropriate line of your tax return. Irs1040 For information on educational assistance programs, see Educational Assistance in section 2 of Publication 15-B. Irs1040 Fringe Benefits A fringe benefit is a form of pay for the performance of services. Irs1040 You can generally deduct the cost of fringe benefits. Irs1040 You may be able to exclude all or part of the value of some fringe benefits from your employees' pay. Irs1040 You also may not owe employment taxes on the value of the fringe benefits. Irs1040 See Table 2-1, Special Rules for Various Types of Fringe Benefits, in Publication 15-B for details. Irs1040 Your deduction for the cost of fringe benefits for activities generally considered entertainment, amusement, or recreation, or for a facility used in connection with such an activity (for example, a company aircraft) for certain officers, directors, and more-than-10% shareholders is limited. Irs1040 Certain fringe benefits are discussed next. Irs1040 See Publication 15-B for more details on these and other fringe benefits. Irs1040 Meals and lodging. Irs1040   You can usually deduct the cost of furnishing meals and lodging to your employees. Irs1040 Deduct the cost in whatever category the expense falls. Irs1040 For example, if you operate a restaurant, deduct the cost of the meals you furnish to employees as part of the cost of goods sold. Irs1040 If you operate a nursing home, motel, or rental property, deduct the cost of furnishing lodging to an employee as expenses for utilities, linen service, salaries, depreciation, etc. Irs1040 Deduction limit on meals. Irs1040   You can generally deduct only 50% of the cost of furnishing meals to your employees. Irs1040 However, you can deduct the full cost of the following meals. Irs1040 Meals whose value you include in an employee's wages. Irs1040 Meals that qualify as a de minimis fringe benefit as discussed in section 2 of Publication 15-B. Irs1040 This generally includes meals you furnish to employees at your place of business if more than half of these employees are provided the meals for your convenience. Irs1040 Meals you furnish to your employees at the work site when you operate a restaurant or catering service. Irs1040 Meals you furnish to your employees as part of the expense of providing recreational or social activities, such as a company picnic. Irs1040 Meals you are required by federal law to furnish to crew members of certain commercial vessels (or would be required to furnish if the vessels were operated at sea). Irs1040 This does not include meals you furnish on vessels primarily providing luxury water transportation. Irs1040 Meals you furnish on an oil or gas platform or drilling rig located offshore or in Alaska. Irs1040 This includes meals you furnish at a support camp that is near and integral to an oil or gas drilling rig located in Alaska. Irs1040 Employee benefit programs. Irs1040   Employee benefit programs include the following. Irs1040 Accident and health plans. Irs1040 Adoption assistance. Irs1040 Cafeteria plans. Irs1040 Dependent care assistance. Irs1040 Education assistance. Irs1040 Life insurance coverage. Irs1040 Welfare benefit funds. Irs1040   You can generally deduct amounts you spend on employee benefit programs on the applicable line of your tax return. Irs1040 For example, if you provide dependent care by operating a dependent care facility for your employees, deduct your costs in whatever categories they fall (utilities, salaries, etc. Irs1040 ). Irs1040 Life insurance coverage. Irs1040   You cannot deduct the cost of life insurance coverage for you, an employee, or any person with a financial interest in your business, if you are directly or indirectly the beneficiary of the policy. Irs1040 See Regulations section 1. Irs1040 264-1 for more information. Irs1040 Welfare benefit funds. Irs1040   A welfare benefit fund is a funded plan (or a funded arrangement having the effect of a plan) that provides welfare benefits to your employees, independent contractors, or their beneficiaries. Irs1040 Welfare benefits are any benefits other than deferred compensation or transfers of restricted property. Irs1040   Your deduction for contributions to a welfare benefit fund is limited to the fund's qualified cost for the tax year. Irs1040 If your contributions to the fund are more than its qualified cost, carry the excess over to the next tax year. Irs1040   Generally, the fund's “qualified cost” is the total of the following amounts, reduced by the after-tax income of the fund. Irs1040 The cost you would have been able to deduct using the cash method of accounting if you had paid for the benefits directly. Irs1040 The contributions added to a reserve account that are needed to fund claims incurred but not paid as of the end of the year. Irs1040 These claims can be for supplemental unemployment benefits, severance pay, or disability, medical, or life insurance benefits. Irs1040   For more information, see sections 419(c) and 419A of the Internal Revenue Code and the related regulations. Irs1040 Loans or Advances You generally can deduct as wages an advance you make to an employee for services performed if you do not expect the employee to repay the advance. Irs1040 However, if the employee performs no services, treat the amount you advanced as a loan. Irs1040 If the employee does not repay the loan, treat it as income to the employee. Irs1040 Below-market interest rate loans. Irs1040   On certain loans you make to an employee or shareholder, you are treated as having received interest income and as having paid compensation or dividends equal to that interest. Irs1040 See Below-Market Loans in chapter 4. Irs1040 Property If you transfer property (including your company's stock) to an employee as payment for services, you can generally deduct it as wages. Irs1040 The amount you can deduct is the property's fair market value on the date of the transfer less any amount the employee paid for the property. Irs1040 You can claim the deduction only for the tax year in which your employee includes the property's value in income. Irs1040 Your employee is deemed to have included the value in income if you report it on Form W-2, Wage and Tax Statement, in a timely manner. Irs1040 You treat the deductible amount as received in exchange for the property, and you must recognize any gain or loss realized on the transfer, unless it is the company's stock transferred as payment for services. Irs1040 Your gain or loss is the difference between the fair market value of the property and its adjusted basis on the date of transfer. Irs1040 These rules also apply to property transferred to an independent contractor for services, generally reported on Form 1099-MISC, Miscellaneous Income. Irs1040 Restricted property. Irs1040   If the property you transfer for services is subject to restrictions that affect its value, you generally cannot deduct it and do not report gain or loss until it is substantially vested in the recipient. Irs1040 However, if the recipient pays for the property, you must report any gain at the time of the transfer up to the amount paid. Irs1040    “Substantially vested” means the property is not subject to a substantial risk of forfeiture. Irs1040 This means that the recipient is not likely to have to give up his or her rights in the property in the future. Irs1040 Reimbursements for Business Expenses You can generally deduct the amount you pay or reimburse employees for business expenses incurred for your business. Irs1040 However, your deduction may be limited. Irs1040 If you make the payment under an accountable plan, deduct it in the category of the expense paid. Irs1040 For example, if you pay an employee for travel expenses incurred on your behalf, deduct this payment as a travel expense. Irs1040 If you make the payment under a nonaccountable plan, deduct it as wages and include it in the employee's Form W-2. Irs1040 See Reimbursement of Travel, Meals, and Entertainment in chapter 11 for more information about deducting reimbursements and an explanation of accountable and nonaccountable plans. Irs1040 Sick and Vacation Pay Sick pay. Irs1040   You can deduct amounts you pay to your employees for sickness and injury, including lump-sum amounts, as wages. Irs1040 However, your deduction is limited to amounts not compensated by insurance or other means. Irs1040 Vacation pay. Irs1040   Vacation pay is an employee benefit. Irs1040 It includes amounts paid for unused vacation leave. Irs1040 You can deduct vacation pay only in the tax year in which the employee actually receives it. Irs1040 This rule applies regardless of whether you use the cash or accrual method of accounting. Irs1040 Prev  Up  Next   Home   More Online Publications
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Manufacturers' Energy Efficient Appliance Credit

Tax Relief and Job Creation Act of 2010     

Act §709 – Modification and Extension of Energy Efficient Appliance Credit for Appliances Produced After 2010

In General

The Tax Relief and Job Creation Act of 2010 modifies and extends the energy efficient appliance credit for certain dishwashers, clothes washers, and refrigerators manufactured after December 31, 2010. Under Code  §45M(a)(1), the credit may be claimed as part of the Code §38 general business credit for each type of qualified energy efficient appliance produced by the taxpayer during the 2011 calendar year ending with or within the taxpayer’s taxable year.

Credit per Unit Produced Based on Energy Efficiency

The credit may be claimed on each qualifying appliance produced by the taxpayer and is based on the type of appliance, its energy efficiency, and for dishwashers and clothes washers, the amount of water it consumes. The total credit for any type of qualifying appliance is the applicable amount listed below multiplied by the eligible production for such type. §45M(a)(2). For purposes of this code section, the term “produced” includes manufactured.  §45M(f)(7).     

Dishwashers

  • $25 in the case of a dishwasher which is manufactured in calendar year 2011 and which uses no more than 307 kilowatt hours per year and 5.0 gallons per cycle (5.5 gallons per cycle for dishwashers designed for greater than 12 place settings). §45M(b)(1)(C)
  • $50 in the case of a dishwasher which is manufactured in calendar year 2011 and which uses no more than 295 kilowatt hours per year and 4.25 gallons per cycle (4.75 gallons per cycle for dishwashers designed for greater than 12 place settings). §45M(b)(1)(D)
  • $75 in the case of a dishwasher which is manufactured in calendar year 2011 and which uses no more than 280 kilowatt hours per year and 4 gallons per cycle (4.5 gallons per cycle for dishwashers designed for greater than 12 place settings). §45M(b)(1)(E)

The term “dishwasher” means a residential dishwasher subject to the energy conservation standards established by the Department of Energy.  §45M(f)(2) 

 Clothes washers

  • $175 in the case of a top-loading clothes washer manufactured in calendar year 2011 which meets or exceeds a 2.2 modified energy factor and does not exceed a 4.5 water consumption factor. §45M(b)(2)(E)
  • $225 in the case of a clothes washer manufactured in calendar year 2011—(i) which is a top-loading clothes washer and which meets or exceeds a 2.4 modified energy factor and does not exceed a 4.2 water consumption factor, or (ii) which is a front-loading clothes washer and which meets or exceeds a 2.8 modified energy factor and does not exceed a 3.5 water consumption factor. §45M(b)(2)(F)

The term “clothes washer” means a residential model clothes washer, including a commercial residential style coin operated washer.  I.R.C. §45M(f)(3).  The term “top-loading clothes washer” means a clothes washer that has the clothes container compartment access located on the top of the machine and that operates on a vertical axis.  §45M(f)(4)

Refrigerators

The credit for refrigerators is based on their energy savings relative to the energy conservation standards promulgated by the Department of Energy that took effect on July 1, 2001.  §45M(f)(8) 

  • $150 in the case of a refrigerator manufactured in calendar year 2011 which consumes at least 30% less energy than the 2001 energy conservation standards. §45M(b)(3)(E)
  • $200 in the case of a refrigerator manufactured in calendar year 2011 which consumes at least 35% less energy than the 2001 energy conservation standards. §45M(b)(3)(F)

The term “refrigerator” means a residential model automatic defrost refrigerator-freezer that has an internal volume of at least 16.5 cubic feet.  §45M(f)(5)

Eligible Production

The production in a calendar year eligible for the credit includes only the excess of the number of appliances of such type that are produced during such calendar year in the United States over the average number of appliances of such type that were produced by the taxpayer (or any predecessor) in the United States during the preceding 2-calendar year period. §45M(c) 

Limitations

The following limitations on the credit apply to taxable years beginning after December 31, 2010:

Dollar Limitation

The aggregate amount of credit allowed with respect to a taxpayer for any taxable year shall not exceed $25 million reduced by the amount of the credit allowed to the taxpayer (or any predecessor) for all prior taxable years beginning after December 31, 2010.  §45M(e)(1). The $25 million dollar limitation shall not be taken into account for refrigerators eligible for the $200 credit and clothes washers eligible for the $225 credit.  §45M(e)(2)

4% Gross Receipts Limitation

The credit with respect to a taxpayer for the taxable year shall not exceed an amount equal to 4% of the average annual gross receipts of the taxpayer for the 3 taxable years preceding the taxable year in which the credit is determined.   §45M(e)(3)

For purposes of the 4% gross receipts limitation:

  • All controlled groups of corporations, and partnerships or proprietorships that are under common control, that are treated as a single employer under §52(a) or (b) are also treated as a single producer for gross receipts limitation purposes. §45M(e)(4) & §448(c)(2)
  • If the entity was not in existence for the entire preceding 3 taxable years, the percentage of average annual gross receipts are to be applied on the basis of the period during which such entity was in existence. §45M(e)(4) & §448(c)(3)(A)
  • Gross receipts for any taxable year of less than 12 months are to be annualized by multiplying the gross receipts for the short period by 12 and dividing the result by the number of months in the short period. §45M(e)(4) & §448(c)(3)(B)
  • Gross receipts for any taxable year are to be reduced by returns and allowances made during such year.  §45M(e)(4) & §448(c)(3)(C)
  • The preceding 3 year period includes gross receipts of the taxpayer or any predecessor to the taxpayer. §45M(e)(4) & §448(c)(3)(D)

Definition of Controlled Group

Generally, controlled groups of corporations, and partnerships or proprietorships which are under common control that are treated as single employers under §52(a) or (b) are treated as single producers for purposes of the credit. §45M(g)(2)(A). Foreign corporations are not considered excluded members of a controlled group of corporations. §45M(g)(2)(B)

Verification

No amount of credit will be allowed with respect to which a taxpayer has not submitted such information or certification as the Secretary, in consultation with the Secretary of Energy, determines to be necessary.  I.R.C. §45M(g)(3) 

Carryback and Carryforward Rules

While Code §39 generally provides for a 1 year carryback and 20 year carryforward for current year business credits that exceed the limitation of Code §38(c), no portion of the unused business credit can be carried back to a tax year before the first year for which that credit is allowed. §§39(a) & (d) 

Effective Date

Act Sec. 709 applies to qualifying energy efficient appliances produced after December 31, 2010.

Page Last Reviewed or Updated: 14-Feb-2014

The Irs1040

Irs1040 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. Irs1040 Even though the rules do not apply to grantor trusts, partnerships, and S corporations directly, they do apply to the owners of these entities. Irs1040 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. Irs1040 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. Irs1040 See Passive Activity Deductions, later. Irs1040 Passive Activity Loss Generally, the passive activity loss for the tax year is not allowed. Irs1040 However, there is a special allowance under which some or all of your passive activity loss may be allowed. Irs1040 See Special $25,000 allowance , later. Irs1040 Definition of passive activity loss. Irs1040    Generally, your passive activity loss for the tax year is the excess of your passive activity deductions over your passive activity gross income. Irs1040 See Passive Activity Income and Deductions , later. Irs1040   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. Irs1040 For details on net active income, see the Instructions for Form 8810. Irs1040 For the definition of passive activity gross income, see Passive Activity Income , later. Irs1040 For the definition of passive activity deductions, see Passive Activity Deductions , later. Irs1040 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. Irs1040 Allocation of disallowed passive activity loss among activities. Irs1040   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. Irs1040 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. Irs1040 Use Worksheet 5 of Form 8582 to figure the ratable portion of the loss from each activity that is disallowed. Irs1040 Loss from an activity. Irs1040   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. Irs1040   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. Irs1040 See Significant Participation Passive Activities , later. Irs1040 Example. Irs1040 John Pine holds interests in three passive activities, A, B, and C. Irs1040 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. Irs1040 Therefore, a ratable portion of the losses from activities A and B is disallowed. Irs1040 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. Irs1040   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. Irs1040 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. Irs1040 Excluded deductions. Irs1040    “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. Irs1040 See Recharacterization of Passive Income , later. Irs1040 Separately identified deductions. Irs1040   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. Irs1040   Use Form 8582, Worksheet 7, for any activity if you have passive activity deductions for that activity that must be separately identified. Irs1040   Deductions that must be accounted for separately include (but are not limited to) the following deductions. Irs1040 Deductions that arise in a rental real estate activity in tax years in which you actively participate in such activity. Irs1040 See Active participation , later. Irs1040 Deductions that arise in a rental real estate activity in tax years in which you do not actively participate in such activity. Irs1040 See Active participation , later. Irs1040 Losses from sales or exchanges of capital assets. Irs1040 Section 1231 losses. Irs1040 See Section 1231 Gains and Losses in Publication 544, Sales and Other Disposition of Assets, for more information. Irs1040 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. Irs1040 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. Irs1040 For more information, see Regulations section 1. Irs1040 469-1(f)(4). Irs1040 Passive Activity Credit Generally, the passive activity credit for the tax year is disallowed. Irs1040 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. Irs1040 Credits that are included in figuring the general business credit are subject to the passive activity rules. Irs1040 See the Instructions for Form 8582-CR for more information. Irs1040 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). Irs1040 You also must apply the limit on passive activity credits separately to your credits from a passive activity held through a PTP. Irs1040 You can offset deductions from passive activities of a PTP only against income or gain from passive activities of the same PTP. Irs1040 Likewise, you can offset credits from passive activities of a PTP only against the tax on the net passive income from the same PTP. Irs1040 This separate treatment rule also applies to a regulated investment company holding an interest in a PTP for the items attributable to that interest. Irs1040 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. Irs1040 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. Irs1040 These rules do not apply to C corporations. Irs1040 For information, see the Instructions for Schedule F (Form 1040), Profit or Loss From Farming. Irs1040 Passive Activities There are two kinds of passive activities. Irs1040 Trade or business activities in which you do not materially participate during the year. Irs1040 Rental activities, even if you do materially participate in them, unless you are a real estate professional. Irs1040 Material participation in a trade or business is discussed later, under Activities That Are Not Passive Activities . Irs1040 Treatment of former passive activities. Irs1040   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. Irs1040 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. Irs1040 Treat any remaining prior year unallowed loss like you treat any other passive loss. Irs1040   In addition, any prior year unallowed passive activity credits from a former passive activity offset the allocable part of your current year tax liability. Irs1040 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. Irs1040 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). Irs1040 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). Irs1040 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. Irs1040 You generally report trade or business activities on Schedule C, C-EZ, F, or in Part II or III of Schedule E. Irs1040 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. Irs1040 See Real Estate Professional under Activities That Are Not Passive Activities, later. Irs1040 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. Irs1040 It does not matter whether the use is under a lease, a service contract, or some other arrangement. Irs1040 Exceptions. Irs1040   Your activity is not a rental activity if any of the following apply. Irs1040 The average period of customer use of the property is 7 days or less. Irs1040 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. Irs1040 If the activity involves renting more than one class of property, multiply the average period of customer use of each class by a fraction. Irs1040 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. Irs1040 The activity's average period of customer use will equal the sum of the amounts for each class. Irs1040 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. Irs1040 Significant personal services include only services performed by individuals. Irs1040 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. Irs1040 Significant personal services do not include the following. Irs1040 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. Irs1040 You provide extraordinary personal services in making the rental property available for customer use. Irs1040 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. Irs1040 The rental is incidental to a nonrental activity. Irs1040 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. Irs1040 The unadjusted basis of property is its cost not reduced by depreciation or any other basis adjustment. Irs1040 The rental of property is incidental to a trade or business activity if all of the following apply. Irs1040 You own an interest in the trade or business activity during the year. Irs1040 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. Irs1040 Your gross rental income from the property is less than 2% of the smaller of its unadjusted basis or fair market value. Irs1040 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. Irs1040 You customarily make the rental property available during defined business hours for nonexclusive use by various customers. Irs1040 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. Irs1040    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. Irs1040 Special $25,000 allowance. Irs1040   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. Irs1040 This special allowance is an exception to the general rule disallowing the passive activity loss. Irs1040 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. Irs1040   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. Irs1040 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. Irs1040   The maximum special allowance is reduced if your modified adjusted gross income exceeds certain amounts. Irs1040 See Phaseout rule , later. Irs1040 Example. Irs1040 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. Irs1040 She can use $15,000 of her $26,000 loss to offset her $15,000 passive income from the partnership. Irs1040 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). Irs1040 Commercial revitalization deduction (CRD). Irs1040   The special allowance must first be applied to losses from rental real estate activities figured without the CRD. Irs1040 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. Irs1040 You cannot claim a CRD for a building placed in service after December 31, 2009. Irs1040 Active participation. Irs1040   Active participation is not the same as material participation (defined later). Irs1040 Active participation is a less stringent standard than material participation. Irs1040 For example, you may be treated as actively participating if you make management decisions in a significant and bona fide sense. Irs1040 Management decisions that count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and similar decisions. Irs1040   Only individuals can actively participate in rental real estate activities. Irs1040 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. Irs1040   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. Irs1040 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. Irs1040   The choice is irrevocable and cannot be made later than the due date for the estate's first income tax return (including any extensions). Irs1040   Limited partners are not treated as actively participating in a partnership's rental real estate activities. Irs1040   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. Irs1040   Active participation is not required to take the low-income housing credit, the rehabilitation investment credit, or CRD from rental real estate activities. Irs1040 Example. Irs1040 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. Irs1040 He advertised and rented the house to the current tenant himself. Irs1040 He also collected the rents and did the repairs or hired someone to do them. Irs1040 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. Irs1040 Phaseout rule. Irs1040   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). Irs1040 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. Irs1040    Modified adjusted gross income for this purpose is your adjusted gross income figured without the following. Irs1040 Taxable social security and tier 1 railroad retirement benefits. Irs1040 Deductible contributions to individual retirement accounts (IRAs) and section 501(c)(18) pension plans. Irs1040 The exclusion from income of interest from qualified U. Irs1040 S. Irs1040 savings bonds used to pay qualified higher education expenses. Irs1040 The exclusion from income of amounts received from an employer's adoption assistance program. Irs1040 Passive activity income or loss included on Form 8582. Irs1040 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). Irs1040 Any overall loss from a publicly traded partnership (see Publicly Traded Partnerships (PTPs) in the instructions for Form 8582). Irs1040 The deduction for the employer-equivalent portion of self-employment tax. Irs1040 The deduction for domestic production activities. Irs1040 The deduction allowed for interest on student loans. Irs1040 The deduction for qualified tuition and related expenses. Irs1040 Example. Irs1040 During 2013, John was unmarried and was not a real estate professional. Irs1040 For 2013, he had $120,000 in salary and a $31,000 loss from his rental real estate activities in which he actively participated. Irs1040 His modified adjusted gross income is $120,000. Irs1040 When he files his 2013 return, he can deduct only $15,000 of his passive activity loss. Irs1040 He must carry over the remaining $16,000 passive activity loss to 2014. Irs1040 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. Irs1040   A higher phaseout range applies to rehabilitation investment credits from rental real estate activities. Irs1040 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). Irs1040   There is no phaseout of the $25,000 special allowance for low-income housing credits or for the CRD. Irs1040 Ordering rules. Irs1040   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. Irs1040 The portion of passive activity losses not attributable to the CRD. Irs1040 The portion of passive activity losses attributable to the CRD. Irs1040 The portion of passive activity credits attributable to credits other than the rehabilitation and low-income housing credits. Irs1040 The portion of passive activity credits attributable to the rehabilitation credit. Irs1040 The portion of passive activity credits attributable to the low-income housing credit. Irs1040 Activities That Are Not Passive Activities The following are not passive activities. Irs1040 Trade or business activities in which you materially participated for the tax year. Irs1040 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). Irs1040 It does not matter whether you materially participated in the activity for the tax year. Irs1040 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. Irs1040  See Temporary Regulations section 1. Irs1040 469-1T(e)(4)(ii). Irs1040 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. Irs1040 An activity of trading personal property for the account of those who own interests in the activity. Irs1040 See Temporary Regulations section 1. Irs1040 469-1T(e)(6). Irs1040 Rental real estate activities in which you materially participated as a real estate professional. Irs1040 See Real Estate Professional , later. Irs1040 You should not enter income and losses from these activities on Form 8582. Irs1040 Instead, enter them on the forms or schedules you would normally use. Irs1040 Material Participation A trade or business activity is not a passive activity if you materially participated in the activity. Irs1040 Material participation tests. Irs1040    You materially participated in a trade or business activity for a tax year if you satisfy any of the following tests. Irs1040 You participated in the activity for more than 500 hours. Irs1040 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. Irs1040 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. Irs1040 The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. Irs1040 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. Irs1040 See Significant Participation Passive Activities , under Recharacterization of Passive Income, later. Irs1040 You materially participated in the activity for any 5 (whether or not consecutive) of the 10 immediately preceding tax years. Irs1040 The activity is a personal service activity in which you materially participated for any 3 (whether or not consecutive) preceding tax years. Irs1040 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. Irs1040 Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the year. Irs1040   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. Irs1040 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). Irs1040 Participation. Irs1040   In general, any work you do in connection with an activity in which you own an interest is treated as participation in the activity. Irs1040 Work not usually performed by owners. Irs1040   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. Irs1040 The work is not work that is customarily done by the owner of that type of activity. Irs1040 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. Irs1040 Participation as an investor. Irs1040   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. Irs1040 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. Irs1040 Spouse's participation. Irs1040   Your participation in an activity includes your spouse's participation. Irs1040 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. Irs1040 Proof of participation. Irs1040 You can use any reasonable method to prove your participation in an activity for the year. Irs1040 You do not have to keep contemporaneous daily time reports, logs, or similar documents if you can establish your participation in some other way. Irs1040 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. Irs1040 Limited partners. Irs1040   If you owned an activity as a limited partner, you generally are not treated as materially participating in the activity. Irs1040 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. Irs1040   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). Irs1040 Retired or disabled farmer and surviving spouse of a farmer. Irs1040   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. Irs1040 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. Irs1040 Corporations. Irs1040   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. Irs1040   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. Irs1040 See Special exception for qualified corporations under Activities Covered by the At-Risk Rules, later. Irs1040 Real Estate Professional Generally, rental activities are passive activities even if you materially participated in them. Irs1040 However, if you qualified as a real estate professional, rental real estate activities in which you materially participated are not passive activities. Irs1040 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. Irs1040 See the Instructions for Schedule E (Form 1040), Supplemental Income and Loss, for information about making this choice. Irs1040 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). Irs1040 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. Irs1040 Qualifications. Irs1040   You qualified as a real estate professional for the year if you met both of the following requirements. Irs1040 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. Irs1040 You performed more than 750 hours of services during the tax year in real property trades or businesses in which you materially participated. Irs1040   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. Irs1040 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. Irs1040   If you file a joint return, do not count your spouse's personal services to determine whether you met the preceding requirements. Irs1040 However, you can count your spouse's participation in an activity in determining if you materially participated. Irs1040 Real property trades or businesses. Irs1040   A real property trade or business is a trade or business that does any of the following with real property. Irs1040 Develops or redevelops it. Irs1040 Constructs or reconstructs it. Irs1040 Acquires it. Irs1040 Converts it. Irs1040 Rents or leases it. Irs1040 Operates or manages it. Irs1040 Brokers it. Irs1040 Closely held corporations. Irs1040   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. Irs1040 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. Irs1040 Self-charged interest. Irs1040   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. Irs1040   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. Irs1040 This includes both loans you made to the partnership or S corporation and loans the partnership or S corporation made to you. Irs1040   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. Irs1040    Exception. Irs1040 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. Irs1040 469-7(g) to avoid the application of these rules. Irs1040 For more details on the self-charged interest rules, see Regulations section 1. Irs1040 469-7. Irs1040 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. Irs1040 Passive activity income does not include the following items. Irs1040 Income from an activity that is not a passive activity. Irs1040 These activities are discussed under Activities That Are Not Passive Activities , earlier. Irs1040 Portfolio income. Irs1040 This includes interest, dividends, annuities, and royalties not derived in the ordinary course of a trade or business. Irs1040 It includes gain or loss from the disposition of property that produces these types of income or that is held for investment. Irs1040 The exclusion for portfolio income does not apply to self-charged interest treated as passive activity income. Irs1040 For more information on self-charged interest, see Self-charged interest , earlier. Irs1040 Personal service income. Irs1040 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. Irs1040 Income from positive section 481 adjustments allocated to activities other than passive activities. Irs1040 (Section 481 adjustments are adjustments that must be made due to changes in your accounting method. Irs1040 ) Income or gain from investments of working capital. Irs1040 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. Irs1040 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. Irs1040 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. Irs1040 Any other income that must be treated as nonpassive income. Irs1040 See Recharacterization of Passive Income , later. Irs1040 Overall gain from any interest in a publicly traded partnership. Irs1040 See Publicly Traded Partnerships (PTPs) in the instructions for Form 8582. Irs1040 State, local, and foreign income tax refunds. Irs1040 Income from a covenant not to compete. Irs1040 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. Irs1040 Alaska Permanent Fund dividends. Irs1040 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. Irs1040 See chapter 4 of Publication 535, Business Expenses, for information about the rules for allocating interest. Irs1040 Disposition of property interests. Irs1040   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. Irs1040 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. Irs1040 An exception to this general rule may apply if you previously used the property in a different activity. Irs1040 Exception for more than one use in the preceding 12 months. Irs1040   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. Irs1040 Any gain allocated to a passive activity is passive activity income. Irs1040   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. Irs1040 Exception for substantially appreciated property. Irs1040   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. Irs1040 You used the property in a passive activity for 20% of the time you held your interest in the property. Irs1040 You used the property in a passive activity for the entire 24-month period before its disposition. Irs1040 If neither condition applies, the gain is not passive activity income. Irs1040 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. Irs1040   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. Irs1040 Also, treat the date you agree to transfer your interest for a fixed or determinable amount as the disposition date. Irs1040   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. Irs1040 Disposition of property converted to inventory. Irs1040   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. Irs1040 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. Irs1040 This rule applies only if you meet all of the following conditions. Irs1040 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). Irs1040 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. Irs1040 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. Irs1040 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. Irs1040 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. Irs1040 See Coordination with other limitations on deductions that apply before the passive activity rules , later. Irs1040 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. Irs1040 Exceptions. Irs1040   Passive activity deductions do not include the following items. Irs1040 Deductions for expenses (other than interest expense) that are clearly and directly allocable to portfolio income. Irs1040 Qualified home mortgage interest, capitalized interest expenses, and other interest expenses (other than self-charged interest) properly allocable to passive activities. Irs1040 For more information on self-charged interest, see Self-charged interest under Passive Activity Income and Deductions, earlier. Irs1040 Losses from dispositions of property that produce portfolio income or property held for investment. Irs1040 State, local, and foreign income taxes. Irs1040 Miscellaneous itemized deductions that may be disallowed because of the 2%-of-adjusted-gross-income limit. Irs1040 Charitable contribution deductions. Irs1040 Net operating loss deductions. Irs1040 Percentage depletion carryovers for oil and gas wells. Irs1040 Capital loss carrybacks and carryovers. Irs1040 Items of deduction from a passive activity that are disallowed under the limits on deductions that apply before the passive activity rules. Irs1040 See Coordination with other limitations on deductions that apply before the passive activity rules , later. Irs1040 Deductions and losses that would have been allowed for tax years beginning before 1987 but for basis or at-risk limits. Irs1040 Net negative section 481 adjustments allocated to activities other than passive activities. Irs1040 (Section 481 adjustments are adjustments required due to changes in accounting methods. Irs1040 ) Casualty and theft losses, unless losses similar in cause and severity recur regularly in the activity. Irs1040 The deduction for the employer-equivalent portion of self-employment tax. Irs1040 Coordination with other limitations on deductions that apply before the passive activity rules. Irs1040   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. Irs1040 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. Irs1040 Proration of deductions disallowed under basis limitations. Irs1040   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. Irs1040 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. Irs1040   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. Irs1040 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. Irs1040 Proration of deductions disallowed under at-risk limitation. Irs1040   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. Irs1040 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. Irs1040 Coordination of basis and at-risk limitations. Irs1040   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. Irs1040 Separately identified items of deduction and loss. Irs1040   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. Irs1040   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. Irs1040 See Grouping Your Activities , later. Irs1040 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). Irs1040 See Section 1231 Gains and Losses in Publication 544 for more information. Irs1040 Are attributable to pre-enactment interests in activities. Irs1040 See Regulations section 1. Irs1040 469-11T(c). Irs1040 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. Irs1040 Grouping is important for a number of reasons. Irs1040 If you group two activities into one larger activity, you need only show material participation in the activity as a whole. Irs1040 But if the two activities are separate, you must show material participation in each one. Irs1040 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. Irs1040 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. Irs1040 Grouping can also be important in determining whether you meet the 10% ownership requirement for actively participating in a rental real estate activity. Irs1040 Appropriate Economic Units Generally, to determine if activities form an appropriate economic unit, you must consider all the relevant facts and circumstances. Irs1040 You can use any reasonable method of applying the relevant facts and circumstances in grouping activities. Irs1040 The following factors have the greatest weight in determining whether activities form an appropriate economic unit. Irs1040 All of the factors do not have to apply to treat more than one activity as a single activity. Irs1040 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. Irs1040 Example 1. Irs1040 John Jackson owns a bakery and a movie theater at a shopping mall in Baltimore and a bakery and movie theater in Philadelphia. Irs1040 Based on all the relevant facts and circumstances, there may be more than one reasonable method for grouping John's activities. Irs1040 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. Irs1040 Example 2. Irs1040 Betty is a partner in ABC partnership, which sells nonfood items to grocery stores. Irs1040 Betty is also a partner in DEF (a trucking business). Irs1040 ABC and DEF are under common control. Irs1040 The main part of DEF's business is transporting goods for ABC. Irs1040 DEF is the only trucking business in which Betty is involved. Irs1040 Based on the rules of this section, Betty treats ABC's wholesale activity and DEF's trucking activity as a single activity. Irs1040 Consistency and disclosure requirement. Irs1040   Generally, when you group activities into appropriate economic units, you may not regroup those activities in a later tax year. Irs1040 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. Irs1040   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. Irs1040   See Disclosure Requirement , later. Irs1040 Regrouping by the IRS. Irs1040   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. Irs1040 Rental activities. Irs1040   In general, you cannot group a rental activity with a trade or business activity. Irs1040 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. Irs1040 Example. Irs1040 Herbert and Wilma are married and file a joint return. Irs1040 Healthy Food, an S corporation, is a grocery store business. Irs1040 Herbert is Healthy Food's only shareholder. Irs1040 Plum Tower, an S corporation, owns and rents out the building. Irs1040 Wilma is Plum Tower's only shareholder. Irs1040 Plum Tower rents part of its building to Healthy Food. Irs1040 Plum Tower's grocery store rental business and Healthy Food's grocery business are not insubstantial in relation to each other. Irs1040 Herbert and Wilma file a joint return, so they are treated as one taxpayer for purposes of the passive activity rules. Irs1040 The same owner (Herbert and Wilma) owns both Healthy Food and Plum Tower with the same ownership interest (100% in each). Irs1040 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. Irs1040 Grouping of real and personal property rentals. Irs1040   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. Irs1040 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. Irs1040 Certain activities may not be grouped. Irs1040   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. Irs1040 Holding, producing, or distributing motion picture films or video tapes. Irs1040 Farming. Irs1040 Leasing any section 1245 property (as defined in section 1245(a)(3) of the Internal Revenue Code). Irs1040 For a list of section 1245 property, see Section 1245 property under Activities Covered by the At-Risk Rules , later. Irs1040 Exploring for, or exploiting, oil and gas resources. Irs1040 Exploring for, or exploiting, geothermal deposits. Irs1040   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. Irs1040 Limited entrepreneur. Irs1040   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. Irs1040 Activities conducted through another entity. Irs1040   A personal service corporation, closely held corporation, partnership, or S corporation must group its activities using the rules discussed in this section. Irs1040 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. Irs1040    You may not treat activities grouped together by the entity as separate activities. Irs1040 Personal service and closely held corporations. Irs1040   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. Irs1040 See Material Participation , earlier, and Significant Participation Passive Activities , later. Irs1040 Publicly traded partnership (PTP). Irs1040   You may not group activities conducted through a PTP with any other activity, including an activity conducted through another PTP. Irs1040 Partial dispositions. Irs1040   If you dispose of substantially all of an activity during your tax year, you may treat the part disposed of as a separate activity. Irs1040 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. Irs1040 Disclosure Requirement For tax years beginning after January 24, 2010, the following disclosure requirements for groupings apply. Irs1040 You are required to report certain changes to your groupings that occur during the tax year to the IRS. Irs1040 If you fail to report these changes, each trade or business activity or rental activity will be treated as a separate activity. Irs1040 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. Irs1040 If the IRS discovered the failure to disclose, you must have reasonable cause for not making the required disclosure. Irs1040 New grouping. Irs1040   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. Irs1040 The statement must provide the names, addresses, and employer identification numbers (EINs), if applicable, for the activities being grouped as a single activity. Irs1040 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. Irs1040 Addition to an existing grouping. Irs1040   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. Irs1040 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. Irs1040 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. Irs1040 Regrouping. Irs1040   You must file a written statement with your original income tax return for the tax year in which you regroup the activities. Irs1040 The statement must provide the names, addresses, and EINs, if applicable, for the activities that are being regrouped. Irs1040 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. Irs1040 In addition, the statement must contain an explanation of the material change in the facts and circumstances that made the original grouping clearly inappropriate. Irs1040 Groupings by partnerships and S corporations. Irs1040   Partnerships and S corporations are not subject to the rules for new grouping, addition to an existing grouping, or regrouping. Irs1040 Instead, they must comply with the disclosure instructions for grouping activities provided in their Form 1065, U. Irs1040 S. Irs1040 Return of Partnership Income, or Form 1120S, U. Irs1040 S. Irs1040 Income Tax Return for an S Corporation, whichever is applicable. Irs1040   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. Irs1040   A partner or shareholder may not treat activities grouped together by the entity as separate activities. Irs1040 Recharacterization of Passive Income Net income from the following passive activities may have to be recharacterized and excluded from passive activity income. Irs1040 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. Irs1040 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. Irs1040 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). Irs1040 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. Irs1040 Instead, enter income or losses on the form and schedules you normally use. Irs1040 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. Irs1040 Limit on recharacterized passive income. Irs1040   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. Irs1040 Investment income and investment expense. Irs1040   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. Irs1040 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. Irs1040 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. Irs1040 Corporations. Irs1040   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. Irs1040 The corporation is not treated as materially participating in the activity for the year. Irs1040 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. Irs1040 Worksheet A. Irs1040   Complete Worksheet A. Irs1040 Significant Participation Passive Activities , below, if you have income or losses from any significant participation activity. Irs1040 Begin by entering the name of each activity in the left column. Irs1040 Column (a). Irs1040   Enter the number of hours you participated in each activity and total the column. Irs1040   If the total is more than 500, do not complete Worksheet A or B. Irs1040 None of the activities are passive activities because you satisfy test 4 for material participation. Irs1040 (See Material participation tests , earlier. Irs1040 ) Report all the income and losses from these activities on the forms and schedules you normally use. Irs1040 Do not include the income and losses on Form 8582. Irs1040 Column (b). Irs1040   Enter the net loss, if any, from the activity. Irs1040 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). Irs1040 Enter -0- here if the prior year unallowed loss is the same as the current year net income. Irs1040 Column (c). Irs1040   Enter net income (if any) from the activity. Irs1040 Net income means the excess of the current year's net income from the activity over any prior year unallowed losses from the activity. Irs1040 Column (d). Irs1040   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). Irs1040 If column (d) is a net loss, skip Worksheet B, Significant Participation Activities With Net Income. Irs1040 Include the income and losses in Worksheet 3 of Form 8582 (or Worksheet 2 in the Form 88