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:: Passive Activity Loss ATG - Exhibit 8.1: Activities (Grouping Entities)
Exhibit 8.1:
Activities (Grouping
Entities)
ISSUE: Does the
grouping form an
appropriate economic
unit? In other
words, in a
realistic sense,
does the grouping
form an
interrelated,
integrated economic
unit? Taxpayers may
group related
business entities
into one single
activity in order to
meet the 500 hour
test for material
participation in
Reg. §
1.469-5T(a)(1).
Conversely, some
taxpayers may
attempt to separate
inherently related
activities in an
attempt to create
purported passive
income which would
trigger otherwise
unallowable passive
losses. In abusive
situations,
particularly with
passive income, the
Government may
regroup activities
to prevent the
taxpayer from
circumventing IRC §
469.
LAW: Under Reg.
§ 1.469-4, if
businesses form an
economic unit, the
taxpayer may group
Schedule C/F, C or S
Corporation and
partnerships/ LLCs
into a single
activity. Rentals
may not be grouped
with a business
unless owned in
identical
percentages as the
business or
insubstantial in
relation to the
business.
_____ At the
initial appointment
or first IDR, ask if
entities were
grouped. Request
statement as to how
activities are
grouped, which
entities or
undertakings are
grouped, and why
they form an
appropriate economic
unit.
_____ If the
taxpayer states that
he has grouped
activities, ask
when the
grouping decision
was made and request
tax workpapers or
other documents
addressing the
entities grouped.
While not absolutely
critical to the
issue, the failure
to provide any
written
documentation
generated at the
time of return
filing (either in
current or prior
years) is an
indicator that
taxpayer did not
group his
activities. In
other words, each
activity is
separate. The
decision to group or
not group is not
made at the time of
an audit. It is a
decision which
generally should
have been made in
1994 or in the year
the interest in the
activity was
acquired, whichever
is later. The Reg.
§ 1.469-4(e)
contains a
consistency
requirement from
year to year and
provides that
taxpayer may not
regroup (unless
original grouping
was inappropriate or
there is a material
change). The Reg. §
1.469-4(g) does not
permit losses to be
deducted under the
"substantially all"
provision unless the
taxpayer can
establish amount of
deductions and
credits allocable to
that part of the
activity.
Obviously, in both
instances, it is
critical to know
what constitutes the
"activity".
_____ Separate
businesses from:
-
Any rental or
leasing activity
-
Portfolio
activities
(stocks, bonds,
securities,
etc.)
-
Land held for
investment (IRC
§
469(e)(1)(A)(ii)(II))
_____ Verify
the
grouping
forms an
appropriate
economic
unit based
on:
__Similarities
__Location
__Ownership
__Common control
and
__Interdependencies
(purchase or
sell goods
between
themselves,
involve products
or services that
are generally
provided
together, the
same customers,
the same
employees, or
use a single set
of books and
records to
account for the
activities).
Not
all factors are
necessary, and there
is no factor which
is required to be
present. Instead,
the appropriateness
of the grouping
should be based on
all the facts and
circumstances. It
is important that
examiner address the
5 factors and
anything else that
points to the
appropriateness or
inappropriateness of
the
grouping
_____ Ensure the
taxpayer has not
grouped rentals
with
businesses
unless:
-
Insubstantial;
OR,
-
Owned in the
same
percentage and
the rental is
leased to the
business.
_____ Verify that
limited partners in
IRC § 465(c)(1)
activities (equipment
leasing, farming,
etc.) have
not been
grouped
unless in the same
line of business.
_____ Ensure that
the grouping was not
to circumvent
the passive
loss
limitations.
Have similar
businesses been
treated as
separate
activities in order
to create passive
income? If so,
under the anti-abuse
provisions, the
Commissioner can
regroup. Scrutinize
carefully any entity
which produces
purported passive
income, but is
related or in the
same line of
business as other
non-passive
activities. See
example in Reg. §
1.469-4(f)(2).
_____ Review
prior and subsequent
year returns for
passive and
non-passive losses
and income to verify
that the same
grouping has been
used
consistently.
Do a comparative
analysis of three
years (or more) on
an entity by entity
basis. Reg. §
1.469-4(e) provides
that once the
taxpayer has grouped
activities he cannot
regroup in
subsequent years
unless the original
grouping was clearly
inappropriate or a
material change
makes the original
grouping
inappropriate.
_____ To verify
material
participation,
request written
documentation,
explaining the
activities performed
and hours the
taxpayer applied
to each
entity.
Also, inquire how
much time the
taxpayer applies to
his rental
activities, on
portfolio
activities, on
hobbies, on
vacation, etc. See
Log at end of
Chapter 4.
_____ Always
inquire whether the
spouse is involved
in business
activities, which
ones, and how much
time. Both
spouses’ time
counts.
Furthermore, one
spouse's
participation is
attributed to the
other spouse. Even
if the spouse does
nothing, if the
other spouse
materially
participates, income
or losses are
non-passive. See
IRC § 469(h)(5) and
Reg. §
1.469-5T(f)(3)
_____ If the
taxpayer argues on
audit that he is
grouping entities,
some which were
listed as passive
and some which were
listed as
non-passive, check
the Form 8582
worksheets to see if
each entity was
listed separately.
If so, it is an
indicator that
taxpayer did not
group. Page 8 of
the Instructions for
Form 8582 advise the
taxpayer to enter
income and losses
for each activity
for columns (a), (b)
and (c). The
instructions clearly
state that each
activity should be
entered (not each
entity). Proper
allocations are
important to
determine the
correct gain on
disposition and
because there is a
consistency
requirement for
groupings.
CONCLUSION: In
accordance with Reg.
§ 1.469-4, the
taxpayer's
businesses have/have
not been properly
grouped.
NOTE: If the
taxpayer is a real
estate professional
as defined in IRC §
469(c)(7), to group
rentals, he MUST
file a timely
written
election with his
return. See Reg. §
1.469-9(g) and Reg.
§ 1.469-11(a)(3).
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