Publication 925, Passive Activity and At-Risk Rules

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Publication 925 Cat. No. 64265X Contents

Future Developments ...... 1 Department of the Passive Activity Reminders ...... 1 Treasury Internal Introduction ...... 2 Revenue and Service Passive Activity Limits ...... 2 Who Must Use These Rules? ...... 2 At-Risk Rules Passive Activities ...... 3 Activities That Aren’t Passive Activities ...... 5 Passive Activity Income and For use in preparing Deductions ...... 6 Grouping Your Activities ...... 8 Recharacterization of Passive 2020 Returns Income ...... 10 Dispositions ...... 11 How To Report Your Passive Activity Loss ...... 12

At-Risk Limits ...... 12 Who Is Affected? ...... 12 Activities Covered by the At-Risk Rules ...... 13 At-Risk Amounts ...... 14 Amounts Not at Risk ...... 14 Reductions of Amounts at Risk .... 15 Recapture Rule ...... 15

How To Get Tax Help ...... 15

Index ...... 17

Future Developments For the latest developments related to Pub. 925, such as legislation enacted after it was published, go to IRS.gov/Pub925.

Reminders Regrouping due to Net Investment Income Tax. You may be able to regroup your activities if you’re subject to the Net Investment Income Tax. See Regrouping Due to Net Investment In- come Tax under Grouping Your Activities, later, for more information. At-risk amounts. The following rules apply to amounts borrowed after May 3, 2004. • You must file Form 6198, At-Risk Limita- tions, if you’re engaged in an activity included in (6) under Activities Covered by the At-Risk Rules and you have borrowed certain amounts described in Certain borrowed amounts excluded under At-Risk Amounts in this publication. • You may be considered at risk for certain amounts described in Certain borrowed amounts excluded under At-Risk Amounts secured by real property used in the activity of holding real property (other than min- Get forms and other information faster and easier at: eral property) that, if nonrecourse, would be qualified nonrecourse financing. • IRS.gov (English) • IRS.gov/Korean (한국어) • IRS.gov/Spanish (Español) • IRS.gov/Russian (Pусский) Photographs of missing children. The Inter- • IRS.gov/Chinese (中文) • IRS.gov/Vietnamese (Tiếng Việt) nal Revenue Service is a proud partner with the National Center for Missing & Exploited

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Children® (NCMEC). Photographs of missing 8810 8810 Corporate Passive Activity Loss and each of your passive activities is disallowed. children selected by the Center may appear in Credit Limitations The ratable portion of a loss from an activity is this publication on pages that would otherwise computed by multiplying the passive activity be blank. You can help bring these children 8949 8949 Sales and Other Dispositions of loss that’s disallowed for the tax year by the home by looking at the photographs and calling Capital Assets fraction obtained by dividing: 800-THE-LOST (800-843-5678) if you recog- See How To Get Tax Help at the end of this 1. The loss from the activity for the tax year; nize a child. publication for information about getting these by publications and forms. 2. The sum of the losses for the tax year from Introduction all activities having losses for the tax year. This publication discusses two sets of rules that Passive Activity Limits Use Worksheet 5 of Form 8582 to figure the rat- may limit the amount of your deductible loss able portion of the loss from each activity that’s from a trade, business, rental, or other in- disallowed. come-producing activity. The first part of the Who Must Use These Rules? publication discusses the passive activity rules. Loss from an activity. The term “loss from The second part discusses the at-risk rules. The passive activity rules apply to: an activity” means: However, when you figure your allowable los- • Individuals, 1. The amount by which the passive activity ses from any activity, you must apply the at-risk • Estates, deductions (defined later) from the activity rules before the passive activity rules. • Trusts (other than grantor trusts), • Personal service corporations, and for the tax year exceed the passive activity Comments and suggestions. We welcome • Closely held corporations. gross income (defined later) from the ac- your comments about this publication and sug- tivity for the tax year; reduced by gestions for future editions. Even though the rules don’t apply to grantor 2. Any part of such amount that’s allowed un- You can send us comments through trusts, partnerships, and S corporations directly, der the Special $25,000 allowance, later. IRS.gov/FormComments. Or, you can write to they do apply to the owners of these entities. the Internal Revenue Service, Tax Forms and If your passive activity gross income from For information about personal service cor- significant participation passive activities (de- Publications, 1111 Constitution Ave. NW, porations and closely held corporations, includ- IR-6526, Washington, DC 20224. fined later) for the tax year is more than your ing definitions and how the passive activity passive activity deductions from those activities Although we can’t respond individually to rules apply to these corporations, see Form for the tax year, those activities shall be treated, each comment received, we do appreciate your 8810 and its instructions. solely for purposes of figuring your loss from the feedback and will consider your comments and activity, as a single activity that doesn’t have a suggestions as we revise our tax forms, instruc- Before applying the passive activity loss for such taxable year. See Significant Par- tions, and publications. Do not send tax ques- limits, you must first determine the ! ticipation Passive Activities, later. tions, tax returns, or payments to the above ad- CAUTION amount of the deductions disallowed dress. under the basis, excess farm loss, or at-risk rules. See Passive Activity Deductions, later. Example. John Pine holds interests in three Getting answers to your tax questions. passive activities, A, B, and C. The gross in- If you have a tax question not answered by this come and deductions from these activities for publication or How To Get Tax Help section at Passive Activity Loss the taxable year are as follows. the end of this publication, go to the IRS Inter- active Tax Assistant page at IRS.gov/Help/ITA Generally, the passive activity loss for the tax A B C Total where you can find topics using the search fea- year isn’t allowed. However, there is a special ture or by viewing the categories listed. allowance under which some or all of your pas- Gross sive activity loss may be allowed. See Special Getting tax forms, instructions, and pub- income $7,000 $4,000 $12,000 $23,000 $25,000 allowance, later. lications. Visit IRS.gov/Forms to download Deductions (16,000) (20,000) (8,000) (44,000) current and prior-year forms, instructions, and Definition of passive activity loss. Gener- publications. ally, your passive activity loss for the tax year is Ordering tax forms, instructions, and the excess of your passive activity deductions Net publications. Go to IRS.gov/OrderForms to over your passive activity gross income. See income ($9,000) ($16,000) $4,000 ($21,000) order current forms, instructions, and publica- Passive Activity Income and Deductions, later. (loss) tions; call 800-829-3676 to order prior-year For a closely held corporation, the passive John Pine’s $21,000 passive activity loss for forms and instructions. Your order should arrive activity loss is the excess of passive activity de- the taxable year is disallowed. Therefore, a rat- within 10 business days. ductions over the sum of passive activity gross income and net active income. For details on able portion of the losses from activities A and B is disallowed. He figures the disallowed por- Useful Items net active income, see the Instructions for Form 8810. For the definition of passive activity gross tion of each loss as follows. You may want to see: income, see Passive Activity Income, later. For the definition of passive activity deductions, see A: $21,000 x $9,000/$25,000 $7,560 Publication Passive Activity Deductions, later. B: $21,000 x $16,000/$25,000 13,440

527 527 Residential Rental Property (Including Rental of Vacation Homes) Identification of Disallowed Total $21,000 Passive Activity Deductions

541 541 Partnerships Allocation within loss activities. If all or any If all or a part of your passive activity loss is dis- Form (and Instructions) part of your loss from an activity is disallowed allowed for the tax year, you may need to allo- under Allocation of disallowed passive activity

4952 4952 Investment Interest Expense cate the disallowed passive activity loss among loss among activities for the tax year, a ratable Deduction different passive activities and among different portion of each of your passive activity deduc- deductions within a passive activity. tions (defined later), other than an excluded de- 6198 6198 At-Risk Limitations duction (defined below) from such activity is Allocation of disallowed passive activity 8582 8582 Passive Activity Loss Limitations disallowed. The ratable portion of a passive ac- loss among activities. If all or any part of your tivity deduction is the amount of the disallowed 8582-CR 8582-CR Passive Activity Credit passive activity loss is disallowed for the tax portion of the loss from the activity for the tax Limitations year, a ratable portion of the loss (if any) from

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year multiplied by the fraction obtained by divid- See the Instructions for Form 8582-CR for Trade or Business Activities ing: more information. A trade or business activity is an activity that: 1. The amount of such deduction; by • Involves the conduct of a trade or business 2. The sum of all of your passive activity de- Publicly Traded Partnership (that is, deductions would be allowable un- ductions (other than excluded deductions) der section 162 of the Internal Revenue You must apply the rules in this part separately from that activity from the tax year. Code if other limitations, such as the pas- to your income or loss from a passive activity sive activity rules, didn’t apply); held through a publicly traded partnership Excluded deductions. “Excluded deduc- Is conducted in anticipation of starting a (PTP). You must also apply the limit on passive • tion” means any passive activity deduction trade or business; or activity credits separately to your credits from a that’s taken into account in computing your net Involves research or experimental expen- passive activity held through a PTP. • income from an item of property for a taxable ditures that are deductible under Internal year in which an amount of the taxpayer's gross You can offset deductions from passive ac- Revenue Code section 174 (or that would income from such item of property is treated as tivities of a PTP only against income or gain be deductible if you chose to deduct rather not from a passive activity. See Recharacteriza- from passive activities of the same PTP. Like- than capitalize them). tion of Passive Income, later. wise, you can offset credits from passive activi- A trade or business activity doesn’t include a Separately identified deductions. In ties of a PTP only against the tax on the net rental activity or the rental of property that’s inci- identifying the deductions from an activity that passive income from the same PTP. This sepa- dental to an activity of holding the property for are disallowed, you don’t need to account separate treatment rule also applies to a regulated investment. rately for a deduction unless such deduction investment company holding an interest in a may, if separately taken into account, result in PTP for the items attributable to that interest. You generally report trade or business activ- an income tax liability for any tax year different For more information on how to apply the ities on Schedule C, F, or in Part II or III of from that which would result were such deduc- passive activity loss rules to PTPs, and on how Schedule E. tion not taken into account separately. to apply the limit on passive activity credits to Use Form 8582, Worksheet 7, for any activ- PTPs, see Publicly Traded Partnerships (PTPs) Rental Activities ity if you have passive activity deductions for in the instructions for Forms 8582 and that activity that must be separately identified. 8582-CR, respectively. A rental activity is a passive activity even if you Deductions that must be accounted for sep- materially participated in that activity, unless arately include (but aren’t limited to) the follow- you materially participated as a real estate pro- ing deductions. Excess Farm Loss fessional. See Real Estate Professional under • Deductions that arise in a rental real estate Activities That Aren’t Passive Activities, later. activity in tax years in which you actively If you have an excess farm loss for the tax year, An activity is a rental activity if tangible property participate in such activity. See Active par- special rules may apply. These rules don’t ap- (real or personal) is used by customers or held ticipation, later. ply to C corporations. For information on excess for use by customers, and the gross income (or • Deductions that arise in a rental real estate farm losses, see the Instructions for Schedule F expected gross income) from the activity repre- activity in tax years in which you don’t ac- (Form 1040), Profit or Loss From Farming. sents amounts paid (or to be paid) mainly for tively participate in such activity. See Ac- the use of the property. It doesn’t matter tive participation, later. Passive Activities whether the use is under a lease, a service con- • Losses from sales or exchanges of capital tract, or some other arrangement. assets. There are two kinds of passive activities. • Section 1231 losses. See Section 1231 • Trade or business activities in which you Exceptions. Your activity isn’t a rental activity Gains and Losses in Pub. 544, Sales and don’t materially participate during the year. if any of the following apply. Other Dispositions of Assets, for more in- • Rental activities, even if you do materially formation. 1. The average period of customer use of the participate in them, unless you’re a real es- property is 7 days or less. You figure the tate professional. Carryover of Disallowed average period of customer use by divid- Material participation in a trade or business is ing the total number of days in all rental Deductions discussed, later, under Activities That Aren’t periods by the number of rentals during Passive Activities. the tax year. If the activity involves renting In the case of an activity with respect to which more than one class of property, multiply any deductions or credits are disallowed for a Treatment of former passive activities. A the average period of customer use of taxable year (the loss activity), the disallowed former passive activity is an activity that was a each class by a fraction. The numerator of deductions are allocated among your activities passive activity in any earlier tax year, but isn’t a the fraction is the gross rental income from for the next tax year in a manner that reasona- passive activity in the current tax year. You can that class of property and the denominator bly reflects the extent to which each activity deduct a prior-year unallowed loss from the ac- is the activity's total gross rental income. continues the loss activity. The disallowed de- tivity up to the amount of your current-year net The activity's average period of customer ductions or credits allocated to an activity under income from the activity. Treat any remaining use will equal the sum of the amounts for the preceding sentence are treated as deduc- prior-year unallowed loss like you treat any each class. tions or credits from the activity for the next tax other passive loss. year. For more information, see Regulations 2. The average period of customer use of the In addition, any prior-year unallowed pas- section 1.469-1(f)(4). property, as figured in (1) above, is 30 sive activity credits from a former passive activ- days or less and you provide significant ity offset the allocable part of your current-year personal services with the rentals. Signifi- tax liability. The allocable part of your cur- Passive Activity Credit cant personal services include only serv- rent-year tax liability is that part of this year's tax ices performed by individuals. To deter- liability that‘s allocable to the current-year net Generally, the passive activity credit for the tax mine if personal services are significant, income from the former passive activity. You year is disallowed. all relevant facts and circumstances are figure this after you reduce your net income taken into consideration, including the fre- from the activity by any prior-year unallowed The passive activity credit is the amount by quency of the services, the type and loss from that activity (but not below zero). which the sum of all your credits subject to the amount of labor required to perform the passive activity rules exceed your regular tax li- services, and the value of the services rel- ability allocable to all passive activities for the ative to the amount charged for use of the tax year. Credits that are included in figuring the property. Significant personal services general business credit are subject to the pas- don’t include the following. sive activity rules.

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a. Services needed to permit the lawful general rule disallowing the passive activity The choice is irrevocable and can’t be made use of the property; loss. Similarly, you can offset credits from the later than the due date for the estate's first in- activity against the tax on up to $25,000 of non- come tax return (including any extensions). b. Services to repair or improve property passive income after taking into account any Limited partners aren’t treated as actively that would extend its useful life for a losses allowed under this exception. participating in a partnership's rental real estate period substantially longer than the activities. average rental; and If you’re married, filing a separate return, and lived apart from your spouse for the entire You aren’t treated as actively participating in c. Services that are similar to those tax year, your special allowance can’t be more a rental real estate activity unless your interest commonly provided with long-term than $12,500. If you lived with your spouse at in the activity (including your spouse's interest) rentals of real estate, such as clean- any time during the year and are filing a sepa- was at least 10% (by value) of all interests in the ing and maintenance of common rate return, you can’t use the special allowance activity throughout the year. areas or routine repairs. to reduce your nonpassive income or tax on Active participation isn’t required to take the low-income housing credit, the rehabilitation in- 3. You provide extraordinary personal serv- nonpassive income. vestment credit, or CRD from rental real estate ices in making the rental property available The maximum special allowance is reduced activities. for customer use. Services are extraordi- if your modified adjusted gross income exceeds nary personal services if they’re performed certain amounts. See Phaseout rule, later. Example. Mike, a single taxpayer, had the by individuals and the customers' use of following income and loss during the tax year. the property is incidental to their receipt of Example. Kate, a single taxpayer, has the services. $70,000 in wages, $15,000 income from a limited partnership, a $26,000 loss from rental real Salary ...... $42,300 4. The rental is incidental to a nonrental ac- estate activities in which she actively participa- Dividends ...... 300 tivity. The rental of property is incidental to ted, and isn’t subject to the modified adjusted Interest ...... 1,400 an activity of holding property for invest- gross income phaseout rule. She can use Rental loss ...... (4,000) ment if the main purpose of holding the $15,000 of her $26,000 loss to offset her The rental loss came from a house Mike property is to realize a gain from its appre- $15,000 passive income from the partnership. owned. He advertised and rented the house to ciation and the gross rental income from She actively participated in her rental real es- the current tenant himself. He also collected the the property is less than 2% of the smaller tate activities, so she can use the remaining rents and did the repairs or hired someone to of the property's unadjusted basis or fair $11,000 rental real estate loss to offset $11,000 do them. market value. The unadjusted basis of of her nonpassive income (wages). property is its cost not reduced by depreci- Even though the rental loss is a loss from a ation or any other basis adjustment. The Commercial revitalization deduction passive activity, Mike can use the entire $4,000 rental of property is incidental to a trade or (CRD). The special allowance must first be loss to offset his other income because he ac- business activity if all of the following ap- applied to losses from rental real estate activi- tively participated. ties figured without the CRD. Any remaining ply. Phaseout rule. The maximum special al- part of the special allowance is available for the lowance of $25,000 ($12,500 for married indi- a. You own an interest in the trade or CRD from the rental real estate activities and viduals filing separate returns and living apart at business activity during the year. isn’t subject to the active participation rules or all times during the year) is reduced by 50% of the phaseout based on modified adjusted gross b. The rental property was used mainly the amount of your modified adjusted gross in- income. in that trade or business activity dur- come that’s more than $100,000 ($50,000 if ing the current year, or during at least You can’t claim a CRD for a building you’re married filing separately). If your modi- 2 of the 5 preceding tax years. ! placed in service after December 31, fied adjusted gross income is $150,000 or more c. Your gross rental income from the CAUTION 2009. ($75,000 or more if you’re married filing sepa- property is less than 2% of the smaller rately), you generally can’t use the special al- of its unadjusted basis or fair market Active participation. Active participation lowance. This is because the special allowance value. Lodging provided to an em- isn’t the same as material participation (defined is reduced to $0 since the modified adjusted ployee or the employee's spouse or later). Active participation is a less stringent gross income is over the $100,000 amount. dependents is incidental to the activity standard than material participation. For exam- Modified adjusted gross income for this pur- or activities in which the employee ple, you may be treated as actively participating pose is your adjusted gross income figured performs services if the lodging is fur- if you make management decisions in a signifi- without the following. nished for the employer's conven- cant and bona fide sense. Management deci- • Taxable social security and Tier 1 railroad ience. sions that count as active participation include retirement benefits. approving new tenants, deciding on rental • Deductible contributions to individual re- 5. You customarily make the rental property terms, approving expenditures, and similar de- tirement accounts (IRAs) and section available during defined business hours cisions. 501(c)(18) pension plans. for nonexclusive use by various custom- Only individuals can actively participate in • The exclusion from income of interest from ers. rental real estate activities. However, a dece- qualified U.S. savings bonds used to pay 6. You provide the property for use in a non- dent's estate is treated as actively participating qualified higher education expenses. rental activity in your capacity as an owner for its tax years ending less than 2 years after • The exclusion from income of amounts re- of an interest in the partnership, S corpo- the decedent's death, if the decedent would ceived from an employer's adoption assis- ration, or joint venture conducting that ac- have satisfied the active participation require- tance program. tivity. ment for the activity for the tax year the dece- • Passive activity income or loss included on dent died. Form 8582. If you meet any of the exceptions listed A decedent's qualified revocable trust can • Any rental real estate loss allowed be- TIP above, see the Instructions for Form also be treated as actively participating if both cause you materially participated in the 8582 for information about how to re- the trustee and the executor (if any) of the es- rental activity as a Real Estate Professio- port any income or loss from the activity. tate choose to treat the trust as part of the es- nal (as discussed, later, under Activities tate. The choice applies to tax years ending af- That Aren’t Passive Activities). Special $25,000 allowance. If you or your ter the decedent's death and before: • Any overall loss from a publicly traded spouse actively participated in a passive rental • 2 years after the decedent's death if no es- partnership (see Publicly Traded Partner- real estate activity, the amount of the passive tate tax return is required, or ships (PTPs) in the instructions for Form activity loss that’s disallowed is decreased and • 6 months after the estate tax liability is fi- 8582). you therefore can deduct up to $25,000 of loss nally determined if an estate tax return is • The deduction allowed for the deductible from the activity from your nonpassive income. required. part of self-employment tax. This special allowance is an exception to the

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• Foreign-derived intangible income and Activities That Aren’t hours during the year and in which you global intangible low-taxed income. Passive Activities didn’t materially participate under any of • The deduction allowed for interest on stu- the material participation tests, other than dent loans. this test. See Significant Participation Pas- • The deduction for qualified tuition and rela- The following aren’t passive activities. sive Activities under Recharacterization of ted expenses. 1. Trade or business activities in which you Passive Income, later. materially participated for the tax year. 5. You materially participated in the activity Example. During 2020, John was unmar- (other than by meeting this fifth test) for ried and wasn’t a real estate professional. For 2. A working interest in an oil or gas well that any 5 (whether or not consecutive) of the 2020, he had $120,000 in salary and a $31,000 you hold directly or through an entity that 10 immediately preceding tax years. loss from his rental real estate activities in which doesn’t limit your liability (such as a gen- he actively participated. His modified adjusted eral partner interest in a partnership). It 6. The activity is a personal service activity in gross income is $120,000. When he files his doesn’t matter whether you materially par- which you materially participated for any 3 2020 return, he can deduct only $15,000 of his ticipated in the activity for the tax year. (whether or not consecutive) preceding passive activity loss. He must carry over the re- However, if your liability was limited for tax years. An activity is a personal service maining $16,000 passive activity loss to 2021. part of the year (for example, you conver- activity if it involves the performance of He figures his deduction and carryover as fol- ted your general partner interest to a limi- personal services in the fields of health (in- lows. ted partner interest during the year) and cluding veterinary services), law, engi- you had a net loss from the well for the neering, architecture, accounting, actuarial year, some of your income and deductions Adjusted gross income, modified as science, performing arts, consulting, or from the working interest may be treated required ...... $120,000 any other trade or business in which capi- as passive activity gross income and pas- tal isn’t a material income-producing fac- Minus amount not subject to phaseout .... –100,000 sive activity deductions. See Temporary tor. Regulations section 1.469-1T(e)(4)(ii). 7. Based on all the facts and circumstances, Amount subject to phaseout rule ...... $20,000 3. The rental of a dwelling unit that you also Multiply by 50% ...... × 50% you participated in the activity on a regu- used for personal purposes during the lar, continuous, and substantial basis dur- year for more than the greater of 14 days ing the year. Required reduction to special or 10% of the number of days during the allowance ...... $10,000 year that the home was rented at a fair You didn’t materially participate in the activ-

Maximum special allowance ...... $25,000 rental. ity under test (7) if you participated in the activity for 100 hours or less during the year. Your 4. An activity of trading personal property for participation in managing the activity doesn’t Minus required reduction (see above) .... –10,000 the account of those who own interests in count in determining whether you materially the activity. See Temporary Regulations participated under this test if: Adjusted special allowance ...... $15,000 section 1.469-1T(e)(6). • Any person other than you received com- Passive loss from rental real estate ...... $31,000 5. Rental real estate activities in which you pensation for managing the activity, or materially participated as a real estate pro- • Any individual spent more hours during the Deduction allowable/Adjusted fessional. See Real Estate Professional, tax year managing the activity than you did special allowance (see above) ...... –15,000 later. (regardless of whether the individual was compensated for the management serv- Amount that must be carried forward ..... $16,000 You shouldn’t enter income and losses ices). ! from these activities on Form 8582. In- Exceptions to the phaseout rules. A CAUTION stead, enter them on the forms or Participation. In general, any work you do in higher phaseout range applies to rehabilitation schedules you would normally use. connection with an activity in which you own an investment credits from rental real estate activi- interest is treated as participation in the activity. ties. For those credits, the phaseout of the Material Participation $25,000 special allowance starts when your Work not usually performed by owners. modified adjusted gross income exceeds You don’t treat the work you do in connection A trade or business activity isn’t a passive activ- with an activity as participation in the activity if $200,000 ($100,000 if you’re a married individ- ity if you materially participated in the activity. ual filing a separate return and living apart at all both of the following are true. • The work isn’t work that’s customarily done times during the year). Material participation tests. You materially There is no phaseout of the $25,000 special by the owner of that type of activity. participated in a trade or business activity for a • One of your main reasons for doing the allowance for low-income housing credits or for tax year if you satisfy any of the following tests. the CRD. work is to avoid the disallowance of any 1. You participated in the activity for more loss or credit from the activity under the Ordering rules. If you have more than one than 500 hours. passive activity rules. of the exceptions to the phaseout rules in the same tax year, you must apply the $25,000 2. Your participation was substantially all the Participation as an investor. You don’t phaseout against your passive activity losses participation in the activity of all individuals treat the work you do in your capacity as an in- and credits in the following order. for the tax year, including the participation vestor in an activity as participation unless of individuals who didn’t own any interest you’re directly involved in the day-to-day man- 1. The portion of passive activity losses not in the activity. agement or operations of the activity. Work you attributable to the CRD. do as an investor includes: 3. You participated in the activity for more • Studying and reviewing financial state- 2. The portion of passive activity losses at- than 100 hours during the tax year, and ments or reports on operations of the activ- tributable to the CRD. you participated at least as much as any ity, other individual (including individuals who 3. The portion of passive activity credits at- • Preparing or compiling summaries or anal- didn’t own any interest in the activity) for tributable to credits other than the rehabili- yses of the finances or operations of the the year. tation and low-income housing credits. activity for your own use, and 4. The portion of passive activity credits at- 4. The activity is a significant participation • Monitoring the finances or operations of tributable to the rehabilitation credit. activity, and you participated in all signifi- the activity in a nonmanagerial capacity. cant participation activities for more than 5. The portion of passive activity credits at- 500 hours. A significant participation activ- Spouse's participation. Your participation in tributable to the low-income housing ity is any trade or business activity in an activity includes your spouse's participation. credit. which you participated for more than 100 This applies even if your spouse didn’t own any

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interest in the activity and you and your spouse complete line 43 of Schedule E (Form 1040). If has the same proportional ownership interest in don’t file a joint return for the year. you also have an unallowed loss from these ac- the lending entity. tivities from an earlier year when you didn’t Proof of participation. You can use Exception. The self-charged interest rules qualify, see Treatment of former passive activi- any reasonable method to prove your don’t apply to your interest in a partnership or S ties under Passive Activities, earlier. corporation if the entity made an election under RECORDS participation in an activity for the year. You don’t have to keep contemporaneous daily Regulations section 1.469-7(g) to avoid the ap- Qualifications. You qualified as a real estate plication of these rules. For more details on the time reports, logs, or similar documents if you professional for the year if you met both of the can establish your participation in some other self-charged interest rules, see Regulations following requirements. section 1.469-7. way. For example, you can show the services • More than half of the personal services you you performed and the approximate number of performed in all trades or businesses dur- Passive Activity Income hours spent by using an appointment book, cal- ing the tax year were performed in real endar, or narrative summary. property trades or businesses in which you Passive activity income includes all income materially participated. from passive activities and generally includes Limited partners. If you owned an activity as a • You performed more than 750 hours of gain from disposition of an interest in a passive limited partner, you generally aren’t treated as services during the tax year in real property activity or property used in a passive activity. materially participating in the activity. However, trades or businesses in which you materi- you’re treated as materially participating in the ally participated. Passive activity income doesn’t include the activity if you met test (1), (5), or (6) under Ma- Don’t count personal services you per- following items. terial participation tests, discussed earlier, for formed as an employee in real property trades Income from an activity that isn’t a passive the tax year. • or businesses unless you were a 5% owner of activity. These activities are discussed un- You aren’t treated as a limited partner, how- your employer. You were a 5% owner if you der Activities That Aren’t Passive Activi- ever, if you were also a general partner in the owned (or are considered to have owned) more ties, earlier. partnership at all times during the partnership's than 5% of your employer's outstanding stock, • Portfolio income. This includes interest, tax year ending with or within your tax year (or, outstanding voting stock, or capital or profits in- dividends, annuities, and royalties not de- if shorter, during that part of the partnership's terest. rived in the ordinary course of a trade or tax year in which you directly or indirectly If you file a joint return, don’t count your business. It includes gain or loss from the owned your limited partner interest). spouse's personal services to determine disposition of property that produces these whether you met the preceding requirements. types of income or that’s held for invest- Retired or disabled farmer and surviving However, you can count your spouse's partici- ment. The exclusion for portfolio income spouse of a farmer. If you’re a retired or disa- pation in an activity in determining if you materi- doesn’t apply to self-charged interest trea- bled farmer, you’re treated as materially partici- ally participated. ted as passive activity income. For more pating in a farming activity if you materially par- information on self-charged interest, see ticipated for 5 or more of the 8 years before Real property trades or businesses. A Self-charged interest, earlier. your retirement or disability. Similarly, if you’re a real property trade or business is a trade or • Personal service income. This includes surviving spouse of a farmer, you’re treated as business that does any of the following with real salaries, wages, commissions, self-em- materially participating in a farming activity if the property. ployment income from trade or business real property used in the activity meets the es- • Develops or redevelops it. activities in which you materially participa- tate tax rules for special valuation of farm prop- • Constructs or reconstructs it. ted, deferred compensation, taxable social erty passed from a qualifying decedent, and • Acquires it. security and other retirement benefits, and you actively manage the farm. • Converts it. payments from partnerships to partners for • Rents or leases it. personal services. Corporations. A closely held corporation or a • Operates or manages it. Income from positive section 481 adjust- personal service corporation is treated as mate- • • Brokers it. ments allocated to activities other than rially participating in an activity only if one or passive activities. (Section 481 adjust- more shareholders holding more than 50% by Closely held corporations. A closely held ments are adjustments that must be made value of the outstanding stock of the corpora- corporation can qualify as a real estate profes- due to changes in your accounting tion materially participate in the activity. sional if more than 50% of the gross receipts for method.) A closely held corporation can also satisfy its tax year came from real property trades or businesses in which it materially participated. • Income or gain from investments of work- the material participation standard by meeting ing capital. the first two requirements for the qualifying busi- • Income from an oil or gas property if you ness exception from the at-risk limits. See Spe- Passive Activity Income treated any loss from a working interest in cial exception for qualified corporations under and Deductions the property for any tax year beginning af- Activities Covered by the At-Risk Rules, later. ter 1986 as a nonpassive loss, as dis- In figuring your net income or loss from a pas- cussed in item (2) under Activities That Real Estate Professional sive activity, take into account only passive ac- Aren’t Passive Activities, earlier. This also tivity income and passive activity deductions. applies to income from other oil and gas Generally, rental activities are passive activities property, the basis of which is determined even if you materially participated in them. Self-charged interest. Certain self-charged wholly or partly by the basis of the property However, if you qualified as a real estate pro- interest income or deductions may be treated in the preceding sentence. fessional, rental real estate activities in which as passive activity gross income or passive ac- • Any income from intangible property, such you materially participated aren’t passive activi- tivity deductions if the loan proceeds are used as a patent, copyright, or literary, musical, ties. For this purpose, each interest you have in in a passive activity. or artistic composition, if your personal ef- a rental real estate activity is a separate activity, Generally, self-charged interest income and forts significantly contributed to the crea- unless you choose to treat all interests in rental deductions result from loans between you and a tion of the property. real estate activities as one activity. See the In- partnership or S corporation in which you had a • Any other income that must be treated as structions for Schedule E (Form 1040), Supple- direct or indirect ownership interest. This in- nonpassive income. See Recharacteriza- mental Income and Loss, for information about cludes both loans you made to the partnership tion of Passive Income, later. making this choice. or S corporation and loans the partnership or S • Overall gain from any interest in a publicly corporation made to you. traded partnership. See Publicly Traded If you qualified as a real estate professional It also includes loans from one partnership Partnerships (PTPs) in the instructions for for 2020, report income or losses from rental or S corporation to another partnership or S cor- Form 8582. real estate activities in which you materially par- poration if each owner in the borrowing entity • State, local, and foreign income tax re- ticipated as nonpassive income or losses, and funds.

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• Income from a covenant not to compete. part of the gain allocated to a passive activity sive Activity Income and Deductions, ear- • Reimbursement of a casualty or theft loss under the rules described in the preceding dis- lier. included in gross income to recover all or cussion. • Losses from dispositions of property that part of a prior-year loss deduction, if the produce portfolio income or property held loss deduction wasn’t a passive activity de- Disposition of property converted to inven- for investment. duction. tory. If you disposed of property that you had • State, local, and foreign income taxes. • Alaska Permanent Fund dividends. converted to inventory from its use in another • Miscellaneous itemized deductions that • Cancellation of debt income, if at the time activity (for example, you sold condominium may be disallowed because of the the debt is discharged the debt isn’t alloca- units you previously held for use in a rental ac- 2%-of-adjusted-gross-income limit. ted to passive activities under the interest tivity), a special rule may apply. Under this rule, • Charitable contribution deductions. expense allocation rules. See chapter 4 of you disregard the property's use as inventory • Net operating loss deductions. Pub. 535, Business Expenses, for informa- and treat it as if it were still used in that other ac- • Percentage depletion carryovers for oil and tion about the rules for allocating interest. tivity at the time of disposition. This rule applies gas wells. only if you meet all of the following conditions. • Capital loss carrybacks and carryovers. Disposition of property interests. Gain on • At the time of disposition, you held your in- • Items of deduction from a passive activity the disposition of an interest in property is gen- terest in the property in a dealing activity that are disallowed under the limits on de- erally passive activity income if, at the time of (an activity that involves holding the prop- ductions that apply before the passive ac- the disposition, the property was used in an ac- erty or similar property mainly for sale to tivity rules. See Coordination with other tivity that was a passive activity in the year of customers in the ordinary course of a trade limitations on deductions that apply before disposition. The gain generally isn’t passive ac- or business). the passive activity rules, later. tivity income if, at the time of disposition, the • Your other activities included a nondealing • Deductions and losses that would have property was used in an activity that wasn’t a activity (an activity that doesn’t involve been allowed for tax years beginning be- passive activity in the year of disposition. An ex- holding similar property for sale to custom- fore 1987 but for basis or at-risk limits. ception to this general rule may apply if you pre- ers in the ordinary course of a trade or • Net negative section 481 adjustments allo- viously used the property in a different activity. business) in which you used the property cated to activities other than passive activi- for more than 80% of the period you held it. ties. (Section 481 adjustments are adjust- Exception for more than one use in the • You didn’t acquire or hold your interest in ments required due to changes in preceding 12 months. If you used the prop- the property for the main purpose of selling accounting methods.) erty in more than one activity during the it to customers in the ordinary course of a • Casualty and theft losses, unless losses 12-month period before its disposition, you trade or business. similar in cause and severity recur regu- must allocate the gain between the activities on larly in the activity. a basis that reasonably reflects the property's Passive Activity Deductions • The deduction allowed for the deductible use during that period. Any gain allocated to a part of self-employment tax. passive activity is passive activity income. Generally, a deduction is a passive activity de- For this purpose, an allocation of the gain Coordination with other limitations on de- solely to the activity in which the property was duction for a taxable year if and only if such deduction either: ductions that apply before the passive ac- mainly used during that period reasonably re- tivity rules. An item of deduction from a pas- flects the property's use if the fair market value 1. Arises in connection with the conduct of sive activity that’s disallowed for a tax year of your interest in the property isn’t more than an activity that’s a passive activity for the under the basis or at-risk limitations isn’t a pas- the lesser of: tax year, or sive activity deduction for the tax year. The fol- • $10,000, or 2. Is treated as a deduction from an activity lowing sections provide rules for figuring the ex- • 10% of the total of the fair market value of tent to which items of deduction from a passive your interest in the property and the fair for the tax year because it was disallowed by the passive activity rules in the preced- activity are disallowed for a tax year under the market value of all other property used in basis or at-risk limitations. that activity immediately before the dispo- ing year and carried forward to the tax sition. year. Proration of deductions disallowed under basis limitations. If any amount of your Exception for substantially appreciated For purposes of item (1) above, an item of distributive share of a partnership's loss for the property. The gain is passive activity income if deduction arises in the taxable year in which the tax year is disallowed under the basis limitation, the fair market value of the property at disposi- item would be allowable as a deduction under a ratable portion of your distributive share of tion was more than 120% of its adjusted basis the taxpayer's method of accounting if taxable each item of deduction or loss of the partner- and either of the following conditions applies. income for all taxable years were determined ship is disallowed for the tax year. For this pur- • You used the property in a passive activity without regard to the passive activity rules and pose, the ratable portion of an item of deduction for 20% of the time you held your interest without regard to the basis, excess farm loss, or loss is the amount of such item multiplied by in the property. and at-risk limits. See Coordination with other the fraction obtained by dividing: • You used the property in a passive activity limitations on deductions that apply before the for the entire 24-month period before its passive activity rules, later. 1. The amount of your distributive share of disposition. partnership loss that’s disallowed for the taxable year, by If neither condition applies, the gain isn’t pas- Passive activity deductions generally in- sive activity income. However, it’s treated as clude any loss from a disposition of property 2. The sum of your distributive shares of all portfolio income only if you held the property for used in a passive activity at the time of the dis- items of deduction and loss of the partner- investment for more than half of the time you position and any loss from a disposition of less ship for the tax year. held it in nonpassive activities. than your entire interest in a passive activity. For this purpose, treat property you held If any amount of your pro rata share of an S through a corporation (other than an S corpora- Exceptions. Passive activity deductions don’t corporation's loss for the tax year is disallowed tion) or other entity whose owners receive only include the following items. under the basis limitation, a ratable portion of portfolio income as property held in a nonpas- • Deductions for expenses (other than inter- your pro rata share of each item of deduction or sive activity and as property held for invest- est expense) that are clearly and directly loss of the S corporation is disallowed for the ment. Also treat the date you agree to transfer allocable to portfolio income. tax year. For this purpose, the ratable portion of your interest for a fixed or determinable amount • Qualified home mortgage interest, capital- an item of deduction or loss is the amount of as the disposition date. ized interest expenses, and other interest such item multiplied by the fraction obtained by If you used the property in more than one expenses (other than self-charged inter- dividing: activity during the 12-month period before its est) properly allocable to passive activities. 1. The amount of your share of S corporation disposition, this exception applies only to the For more information on self-charged inter- loss that’s disallowed for the tax year, by est, see Self-charged interest under Pas-

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2. The sum of your pro rata shares of all Grouping Your Activities • Four separate activities. items of deduction and loss of the corporation for the tax year. You can treat one or more trade or business ac- Example 2. Betty is a partner in ABC partnership, which sells nonfood items to grocery Proration of deductions disallowed un- tivities, or rental activities, as a single activity if those activities form an appropriate economic stores. Betty is also a partner in DEF (a trucking der at-risk limitation. If any amount of your business). ABC and DEF are under common loss from an activity (as defined in Activities unit for measuring gain or loss under the passive activity rules. control. The main part of DEF's business is Covered by the At-Risk Rules, later) is disal- transporting goods for ABC. DEF is the only lowed under the at-risk rules for the tax year, a Grouping is important for a number of rea- trucking business in which Betty is involved. ratable portion of each item of deduction or loss sons. If you group two activities into one larger Based on the rules of this section, Betty treats from the activity is disallowed for the tax year. activity, you need only show material participa- ABC's wholesale activity and DEF's trucking ac- For this purpose, the ratable portion of an item tion in the activity as a whole. But if the two activity as a single activity. of deduction or loss is the amount of such item tivities are separate, you must show material multiplied by the fraction obtained by dividing: participation in each one. On the other hand, if Consistency and disclosure requirement. 1. The amount of the loss from the activity you group two activities into one larger activity Generally, when you group activities into appro- that’s disallowed for the tax year, by and you dispose of one of the two, then you priate economic units, you may not regroup have disposed of only part of your entire inter- those activities in a later tax year. You must 2. The sum of all deductions from the activity est in the activity. But if the two activities are meet any disclosure requirements of the IRS for the taxable year. separate and you dispose of one of them, then when you first group your activities and when you have disposed of your entire interest in that Coordination of basis and at-risk limita- you add or dispose of any activities in your activity. tions. The portion of any item of deduction or groupings. loss that’s disallowed for the tax year under the Grouping can also be important in determin- However, if the original grouping is clearly basis limitations isn’t taken into account for the ing whether you meet the 10% ownership re- inappropriate or there is a material change in taxable year in determining the loss from an ac- quirement for actively participating in a rental the facts and circumstances that makes the tivity (as defined in Activities Covered by the real estate activity. original grouping clearly inappropriate, you At-Risk Rules, later) for purposes of applying must regroup the activities and comply with any the at-risk rules. disclosure requirements of the IRS. Appropriate Economic Units See Disclosure Requirement, later. Separately identified items of deduction Generally, to determine if activities form an ap- and loss. In identifying the items of deduction Regrouping by the IRS. If any of the activities propriate economic unit, you must consider all and loss from an activity that aren’t disallowed resulting from your grouping isn’t an appropriate the relevant facts and circumstances. You can under the basis and at-risk limitations (and that economic unit and one of the primary purposes use any reasonable method of applying the rel- therefore may be treated as passive activity de- of your grouping (or failure to regroup) is to evant facts and circumstances in grouping ac- ductions), you needn’t account separately for avoid the passive activity rules, the IRS may re- tivities. The following factors have the greatest any item of deduction or loss unless such item group your activities. may, if separately taken into account, result in weight in determining whether activities form an appropriate economic unit. All of the factors an income tax liability different from that which Rental activities. In general, you can’t group a don’t have to apply to treat more than one activ- would result were such item of deduction or rental activity with a trade or business activity. ity as a single activity. The factors that you loss taken into account separately. However, you can group them together if the should consider are: Items of deduction or loss that must be ac- activities form an appropriate economic unit counted for separately include (but aren’t limi- 1. The similarities and differences in the and: ted to) items of deduction or loss that: types of trades or businesses; • The rental activity is insubstantial in relation to the trade or business activity; 1. Are attributable to separate activities. See 2. The extent of common control; Grouping Your Activities, later. • The trade or business activity is insubstan- 3. The extent of common ownership; tial in relation to the rental activity; or 2. Arise in a rental real estate activity in tax • Each owner of the trade or business activ- 4. The geographical location; and years in which you actively participate in ity has the same ownership interest in the such activity. 5. The interdependencies between or among rental activity, in which case the part of the 3. Arise in a rental real estate activity in taxa- activities, which may include the extent to rental activity that involves the rental of ble years in which you don’t actively par- which the activities: items of property for use in the trade or business activity may be grouped with the ticipate in such activity. a. Buy or sell goods between or among trade or business activity. 4. Arose in a taxable year beginning before themselves, 1987 and weren’t allowed for such taxable b. Involve products or services that are Example. Herbert and Wilma are married year under the basis or at-risk limitations. generally provided together, and file a joint return. Healthy Food, an S corporation, is a grocery store business. Herbert is 5. Are taken into account under section c. Have the same customers, Healthy Food's only shareholder. Plum Tower, 613A(d) (relating to limitations on certain d. Have the same employees, or an S corporation, owns and rents out the build- depletion deductions). ing. Wilma is Plum Tower's only shareholder. e. Use a single set of books and records 6. Are taken into account under section 1211 Plum Tower rents part of its building to Healthy to account for the activities. (relating to the limitation on capital losses). Food. Plum Tower's grocery store rental business and Healthy Food's grocery business 7. Are taken into account under section 1231 Example 1. John Jackson owns a bakery aren’t insubstantial in relation to each other. (relating to property used in a trade or and a movie theater at a shopping mall in Balti- Herbert and Wilma file a joint return, so business and involuntary conversions). more and a bakery and movie theater in Phila- they’re treated as one taxpayer for purposes of See Section 1231 Gains and Losses in delphia. Based on all the relevant facts and cir- the passive activity rules. The same owner Pub. 544 for more information. cumstances, there may be more than one (Herbert and Wilma) owns both Healthy Food reasonable method for grouping John's activi- 8. Are attributable to pre-enactment interests and Plum Tower with the same ownership inter- ties. For example, John may be able to group in activities. See Regulations section est (100% in each). If the grouping forms an ap- the movie theaters and the bakeries into: 1.469-11T(c). propriate economic unit, as discussed earlier, • One activity, Herbert and Wilma can group Plum Tower's • A movie theater activity and a bakery activ- grocery store rental and Healthy Food's grocery ity, business into a single trade or business activity. • A Baltimore activity and a Philadelphia activity, or

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Grouping of real and personal property Partial dispositions. If you dispose of sub- Manner of regrouping. If you regroup your rentals. In general, you can’t treat an activity stantially all of an activity during your tax year, activities under this rule, you must attach to involving the rental of real property and an ac- you may treat the part disposed of as a sepa- your original or amended return, as applicable, tivity involving the rental of personal property as rate activity. However, you can do this only if a statement that satisfies the requirements de- a single activity. However, you can treat them you can show with reasonable certainty: scribed in Regrouping under Disclosure Re- as a single activity if you provide the personal • The amount of deductions and credits dis- quirement, later. property in connection with the real property or allowed in prior years under the passive the real property in connection with the per- activity rules that’s allocable to the part of Disclosure Requirement sonal property. the activity disposed of, and • The amount of gross income and any other For tax years beginning after January 24, 2010, Certain activities may not be grouped. In deductions and credits for the current tax the following disclosure requirements for group- general, if you own an interest as a limited part- year that’s allocable to the part of the activ- ings apply. You’re required to report certain ner or a limited entrepreneur in one of the fol- ity disposed of. changes to your groupings that occur during the lowing activities, you may not group that activity tax year to the IRS. If you fail to report these with any other activity in another type of busi- changes, each trade or business activity or ness. rental activity will be treated as a separate activ- • Holding, producing, or distributing motion Regrouping Due to Net Investment Income Tax ity. You will be considered to have made a picture films or video tapes. timely disclosure if you filed all affected income • Farming. You may be able to regroup your activities, as tax returns consistent with the claimed grouping • Leasing any section 1245 property (as de- and make the required disclosure on the in- fined in section 1245(a)(3) of the Internal described below, if you’re subject to the Net In- vestment Income Tax (NIIT) for the first time. come tax return for the year in which you first Revenue Code). For a list of section 1245 discovered the failure to disclose. If the IRS dis- property, see Section 1245 property under For detailed information, see Regulations section 1.469-11(b)(3)(iv). covered the failure to disclose, you must have Activities Covered by the At-Risk Rules, reasonable cause for not making the required later. disclosure. • Exploring for, or exploiting, oil and gas re- Regrouping on an original return. Under the NIIT “fresh start” election, you may regroup for sources. the first tax year you are subject to the NIIT New grouping. You must file a written state- • Exploring for, or exploiting, geothermal de- (without regard to the effect of regrouping). You ment with your original income tax return for the posits. may regroup only once under this election and first tax year in which two or more activities are If you own an interest as a limited partner or that regrouping will apply to the tax year for originally grouped into a single activity. The a limited entrepreneur in an activity described in which you regroup and all future tax years. You statement must provide the names, addresses, the list above, you may group that activity with are eligible to regroup if: and employer identification numbers (EINs), if another activity in the same type of business if applicable, for the activities being grouped as a the grouping forms an appropriate economic 1. You were not previously subject to the single activity. In addition, the statement must unit as discussed earlier. NIIT; contain a declaration that the grouped activities 2. The amount you would have entered on make up an appropriate economic unit for the Limited entrepreneur. A limited entrepre- Form 8960, line 12, without the regroup- measurement of gain or loss under the passive neur is a person who: ing, would have been greater than zero; activity rules. • Has an interest in an enterprise other than and as a limited partner, and Addition to an existing grouping. You must • Doesn’t actively participate in the manage- 3. The amount you would have entered on file a written statement with your original income ment of the enterprise. Form 8960, line 13, without the regroup- tax return for the tax year in which you add a ing, would have been greater than the new activity to an existing group. The statement Activities conducted through another en- amount you would have entered on Form must provide the name, address, and EIN, if ap- tity. A personal service corporation, closely 8960, line 14, without the regrouping. plicable, for the activity that’s being added and held corporation, partnership, or S corporation for the activities in the existing group. In addi- must group its activities using the rules dis- Regrouping on an amended return. You tion, the statement must contain a declaration cussed in this section. Once the entity groups may regroup your activities on an amended tax that the activities make up an appropriate eco- its activities, you, as the partner or shareholder return, but only if you were not subject to the nomic unit for the measurement of gain or loss of the entity, may group those activities (follow- NIIT on your original return (or previously amen- under the passive activity rules. ing the rules of this section): ded return). You are eligible if: • With each other, 1. You were not previously subject to the Regrouping. You must file a written statement • With activities conducted directly by you, NIIT for the tax year for which you are filing with your original income tax return for the tax or an amended return or any prior tax year; year in which you regroup the activities. The • With activities conducted through other en- statement must provide the names, addresses, tities. 2. The changes on the amended return and EINs, if applicable, for the activities that are cause you to be subject to the NIIT for the You may not treat activities grouped to- being regrouped. If two or more activities are first time beginning in the taxable year for gether by the entity as separate activi- being regrouped into a single activity, the state- ! which you are amending the return; ment must contain a declaration that the regrou- CAUTION ties. 3. The limitation period for assessments un- ped activities make up an appropriate economic unit for the measurement of gain or loss under Personal service and closely held cor- der Code section 6501 hasn’t ended; the passive activity rules. In addition, the state- porations. You may group an activity conduc- 4. The changes on your amended return ment must contain an explanation of the mate- ted through a personal service or closely held cause the amount on Form 8960, line 12, rial change in the facts and circumstances that corporation with your other activities only to de- of your amended return to be greater than made the original grouping clearly inappropri- termine whether you materially or significantly zero; and ate. participated in those other activities. See Mate- rial Participation, earlier, and Significant Partici- 5. The changes on your amended return Groupings by partnerships and S corpora- pation Passive Activities, later. cause the amount on Form 8960, line 13, tions. Partnerships and S corporations aren’t of your amended return to be greater than subject to the rules for new grouping, addition Publicly traded partnership (PTP). You the amount entered on Form 8960, line 14. may not group activities conducted through a to an existing grouping, or regrouping. Instead, PTP with any other activity, including an activity This rule applies equally to changes to they must comply with the disclosure instruc- conducted through another PTP. modified adjusted gross income or net invest- tions for grouping activities provided in their ment income upon an IRS examination. Form 1065, U.S. Return of Partnership Income,

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or Form 1120-S, U.S. Income Tax Return for an enter income or losses on the form and sched- more than 50% (by value) of the corpora- S Corporation, whichever is applicable. ules you normally use. However, see Significant tion's outstanding stock. The partner or shareholder isn’t required to Participation Passive Activities, later, if the ac- make a separate disclosure of the groupings tivity is a significant participation passive activity Worksheet A. Complete Worksheet A. Signifi- disclosed by the entity unless the partner or and you also have a net loss from a different cant Participation Passive Activities below if you shareholder: significant participation passive activity. have income or losses from any significant par- • Groups together any of the activities that ticipation activity. Begin by entering the name of the entity doesn’t group together, Limit on recharacterized passive income. each activity in the left column. Groups the entity's activities with activities The total amount that you treat as nonpassive • Column (a). Enter the number of hours you conducted directly by the partner or share- income under the rules described later in this participated in each activity and total the col- holder, or discussion for significant participation passive umn. Groups an entity's activities with activities activities, rental of nondepreciable property, • If the total is more than 500, don’t complete conducted through another entity. and equity-financed lending activities can’t exceed the greatest amount that you treat as non- Worksheet A or B. None of the activities are A partner or shareholder may not treat activ- passive income under any one of these rules. passive activities because you satisfy test 4 for ities grouped together by the entity as separate material participation. (See Material participa- activities. Investment income and investment ex- tion tests, earlier.) Report all the income and pense. To figure your investment interest ex- losses from these activities on the forms and Recharacterization pense limitation on Form 4952, treat as invest- schedules you normally use. Don’t include the of Passive Income ment income any net passive income income and losses on Form 8582. recharacterized as nonpassive income from Column (b). Enter the net loss, if any, from Net income from the following passive activities rental of nondepreciable property, equity-fi- the activity. Net loss from an activity means ei- may have to be recharacterized and excluded nanced lending activity, or licensing of intangi- ther: from passive activity income. ble property by a pass-through entity. • The activity's current-year net loss (if any) • Significant participation passive activities, plus prior-year unallowed losses (if any), or • Rental of property when less than 30% of Significant Participation • The excess of prior-year unallowed losses the unadjusted basis of the property is sub- Passive Activities over the current-year net income (if any). ject to depreciation, Enter -0- here if the prior-year unallowed • Equity-financed lending activities, A significant participation passive activity is any loss is the same as the current-year net in- • Rental of property incidental to develop- trade or business activity in which you participa- come. ment activities, ted for more than 100 hours during the tax year Column (c). Enter net income (if any) from • Rental of property to nonpassive activities, but didn’t materially participate. the activity. Net income means the excess of and the current-year net income from the activity • Licensing of intangible property by If your gross income from all significant par- over any prior-year unallowed losses from the pass-through entities. ticipation passive activities is more than your activity. If you’re engaged in or have an interest in one deductions from those activities, a part of your of these activities during the tax year (either di- net income from each significant participation Column (d). Combine amounts in the To- rectly or through a partnership or an S corpora- passive activity is treated as nonpassive in- tals row for columns (b) and (c) and enter the tion), combine the income and losses from the come. total net income or net loss in the Totals row of activity to determine if you have a net loss or net column (d). If column (d) is a net loss, skip income from that activity. Corporations. An activity of a personal service Worksheet B. Significant Participation Activities corporation or closely held corporation is a sig- With Net Income. Include the income and los- If the result is a net loss, treat the income nificant participation passive activity if both of ses in Worksheet 3 of Form 8582 (or Worksheet and losses the same as any other income or the following statements are true. 2 in the Form 8810 instructions). losses from that type of passive activity (trade • The corporation isn’t treated as materially or business activity or rental activity). participating in the activity for the year. If the result is net income, don’t enter any of • One or more individuals, each of whom is the income or losses from the activity or prop- treated as significantly participating in the erty on Form 8582 or its worksheets. Instead, activity, directly or indirectly hold (in total)

Worksheet A. Significant Participation Passive Activities Keep for Your Records

Name of activity (a) Hours of (b) Net loss (c) Net income (d) Combine totals of cols. (b) participation and (c)

( ) /////////////////////////////////////////

Totals ( )

Worksheet B. On Worksheet B. Significant Column (a). Enter the net income of each enter the ratio for each activity as a decimal Participation Activities With Net Income, later, activity from column (c) of Worksheet A. (rounded to at least three places). The total of list only the significant participation passive ac- these ratios must equal 1.000. tivities that have net income as shown in col- Column (b). Divide each of the individual umn (c) of Worksheet A. net income amounts in column (a) by the total of Column (c). Multiply the amount in the To- column (a). The result is a ratio. In column (b), tals row of column (d) of Worksheet A by each

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of the ratios in column (b). Enter the results in Rental of Nondepreciable Property $100,000, and leases the land and improve- column (c). ments to a tenant. He then sells the land and If you have net passive income (including improvements for $600,000, realizing a gain of Column (d). Subtract column (c) from col- prior-year unallowed losses) from renting prop- $200,000 on the disposition. umn (a). To this figure, add the amount of erty in a rental activity, and less than 30% of the The unadjusted basis of the improvements prior-year unallowed losses (if any) that re- unadjusted basis of the property is subject to ($100,000) equals 25% of the unadjusted basis duced the current-year net income. Enter the depreciation, you treat the net passive income of all property ($400,000) used in the rental ac- result in column (d). Enter these amounts on as nonpassive income. tivity. Calvin's net passive income from the ac- Worksheet 3 of Form 8582 or Worksheet 2 in tivity (which is figured with the gain from the dis- the Form 8810 instructions. (Also see Limit on Example. Calvin acquires vacant land for position, including gain from the improvements) recharacterized passive income, earlier.) $300,000, constructs improvements at a cost of is treated as nonpassive income.

Worksheet B. Significant Participation Activities With Net Income Keep for Your Records

Name of activity (b) Ratio (c) Nonpassive income (d) Passive income (a) Net income with net income (see instructions) (see instructions) (subtract col. (c) from col. (a))

Totals 1.000

Equity-Financed described earlier under Rental of Property Inci- year you dispose of your entire interest in the Lending Activities dental to a Development Activity. passive (or former passive) activity. However, for the losses to be allowed, you must dispose If you have gross income from an equity-fi- Licensing of Intangible Property of your entire interest in the activity in a transac- nanced lending activity, the lesser of the net by Pass-Through Entities tion in which all realized gain or loss is recog- passive income or the equity-financed interest nized. Also the person acquiring the interest income is nonpassive income. Net royalty income from intangible property from you must not be related to you. held by a pass-through entity in which you own If you have a capital loss on the dispo- For more information, see Temporary Regu- an interest may be treated as nonpassive roy- ! sition of an interest in a passive activ- lations section 1.469-2T(f)(4). alty income. This applies if you acquired your CAUTION ity, the loss may be limited. For individ- interest in the pass-through entity after the part- uals, your capital loss deduction is limited to the Rental of Property Incidental nership, S corporation, estate, or trust created amount of your capital gains plus the lower of to a Development Activity the intangible property or performed substantial $3,000 ($1,500 in the case of a married individ- services or incurred substantial costs for devel- ual filing a separate return) or the excess of Net income from this type of activity will be trea- oping or marketing the intangible property. your capital losses over capital gains. See Pub. ted as nonpassive income if all of the following 544 for more information. apply. This recharacterization rule doesn’t apply if: • You recognize gain from the sale, ex- 1. The expenses reasonably incurred by the Example. Ray earned a $60,000 salary and change, or other disposition of the rental entity in developing or marketing the prop- owned one passive activity through a 5% inter- property during the tax year. erty exceed 50% of the gross royalties est in the B Limited Partnership. In 2020, he • You started to rent the property less than from licensing the property that are includi- sold his entire partnership interest to an unrela- 12 months before the date of disposition. ble in your gross income for the tax year, ted person for $30,000. His adjusted basis in • You materially participated or significantly or the partnership interest was $42,000, and he participated for any tax year in an activity had carried over $2,000 of ordinary passive ac- 2. Your share of the expenses reasonably in- that involved the performance of services tivity deductions from the activity. curred by the entity in developing or mar- for the purpose of enhancing the value of Ray's deductible loss for 2020 is $5,000, fig- keting the property for all tax years excee- the property (or any other item of property ured as follows. if the basis of the property disposed of is ded 25% of the fair market value of your determined in whole or in part by reference interest in the intangible property at the Amount realized ...... $30,000 to the basis of that item of property). time you acquired your interest in the entity. Minus: adjusted basis ...... –42,000 For more information, see Regulations sec- Capital loss ...... $12,000 For purposes of (2) above, capital expendi- tion 1.469-2(f)(5). Minus: capital loss limit ...... –3,000 tures are taken into account for the entity's tax year in which the expenditure is chargeable to a Capital loss carryover ...... $9,000 Rental of Property to capital account, and your share of the expendi- a Nonpassive Activity ture is figured as if it were allowed as a deduc- Allowable capital loss on sale ...... $3,000 tion for the tax year. Carryover losses allowable ...... 2,000 If you rent property to a trade or business activity in which you materially participated, net Total current deductible loss ...... $5,000 rental income from the property is treated as Dispositions nonpassive income. This rule doesn’t apply to net income from renting property under a writ- Any passive activity losses (but not credits) that Ray deducts the $5,000 total current deduc- ten binding contract entered into before Febru- haven’t been allowed (including current-year tible loss in 2020. He must carry over the re- ary 19, 1988. It also doesn’t apply to property losses) are generally allowed in full in the tax maining $9,000 capital loss, which isn’t subject

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to the passive activity loss limit. He will treat it from a Decedent Dying in 2010, which is availa- 1. You must file Form 6198 with your tax re- like any other capital loss carryover. ble at IRS.gov/pub/irs-prior/p4895--2011.pdf. turn if: a. You have a loss from any part of an Installment sale of an entire interest. If you Partial dispositions. If you dispose of sub- activity that’s covered by the at-risk sell your entire interest in a passive activity stantially all of an activity during your tax year, rules, and through an installment sale to figure the loss for you may be able to treat the part of the activity the current year that isn’t limited by the passive disposed of as a separate activity. See Partial b. You aren’t at risk for some of your in- activity rules, multiply your overall loss (not in- dispositions under Grouping Your Activities, vestment in the activity. cluding losses allowed in prior years) by a frac- earlier. 2. You must file Form 6198 if you’re engaged tion. The numerator of the fraction is the gain in an activity included in (6) under Activi- recognized in the current year, and the denomi- ties Covered by the At-Risk Rules, later, nator is the total gain from the sale minus all How To Report Your and you have borrowed amounts descri- gains recognized in prior years. Passive Activity Loss bed in Certain borrowed amounts exclu- Example. John Ash has a total gain of More than one form or schedule may be re- ded under At-Risk Amounts, later. $10,000 from the sale of an entire interest in a quired for reporting your passive activities. The Loss limits for partners and S corporation passive activity. Under the installment method, actual number of forms depends on the number shareholders. Four separate limits may apply he reports $2,000 of gain each year, including and types of activities you must report. Some to a partner's or shareholder's distributive share the year of sale. For the first year, 20% forms and schedules that may be required are: of an item of deduction or loss from a partner- (2,000/10,000) of the losses are allowed. For • Schedule C (Form 1040), Profit or Loss ship or S corporation, respectively. The limits the second year, 25% (2,000/8,000) of the re- From Business; determine the amount each partner or share- maining losses are allowed. • Schedule D (Form 1040), Capital Gains and Losses; holder can deduct on his or her own return. Partners and S corporation shareholders. • Schedule E (Form 1040), Supplemental In- These limits and the order in which they apply Generally, any gain or loss on the disposition of come and Loss; are: a partnership interest must be allocated to each • Schedule F (Form 1040), Profit or Loss 1. The adjusted basis of: trade or business, rental, or investment activity From Farming; in which the partnership owns an interest. If you • Form 4797, Sales of Business Property; a. The partner's partnership interest, or dispose of your entire interest in a partnership, • Form 6252, Installment Sale Income; b. The shareholder's stock plus any the passive activity losses from the partnership • Form 8582, Passive Activity Loss Limita- loans the shareholder makes to the that haven’t been allowed are generally allowed tions; corporation, in full. They will also be allowed if the partner- • Form 8582-CR, Passive Activity Credit ship (other than a PTP) disposes of all the prop- Limitations; and 2. The excess farm loss rules, erty used in that passive activity. • Form 8949, Sales and Other Dispositions 3. The at-risk rules, and If you don’t dispose of your entire interest, of Capital Assets. 4. The passive activity rules. the gain or loss allocated to a passive activity is Regardless of the number or complexity of treated as passive activity income or deduction See Limitations on Losses, Deductions, and passive activities you have, you should use only in the year of disposition. This includes any gain Credits in Partner's Instructions for Sched- one Form 8582. If you need additional lines for recognized on a distribution of money from the ule K-1 (Form 1065) and Shareholder's Instruc- any of the Form 8582 worksheets, you can ei- partnership that you receive in excess of the ad- tions for Schedule K-1 (Form 1120-S). justed basis of your partnership interest. ther use copies of page 2 or page 3 of Form 8582, whichever is applicable, or your own See Coordination with other limitations on These rules also apply to the disposition of schedule that’s in the same format as the work- deductions that apply before the passive activ- stock in an S corporation. sheet. ity rules, earlier. Dispositions by gift. If you give away your in- For examples and further information, see Who Is Affected? terest in a passive activity, the unused passive the Form 8582 instructions. activity losses allocable to the interest can’t be deducted in any tax year. Instead, the basis of The at-risk limits apply to individuals (including the transferred interest must be increased by partners and S corporation shareholders), es- the amount of these losses. At-Risk Limits tates, trusts, and certain closely held C corporations. Dispositions by death. If a passive activity in- The at-risk rules limit your losses from most ac- terest is transferred because the owner dies, tivities to your amount at risk in the activity. You Closely held C corporation. For the at-risk unused passive activity losses are allowed (to a treat any loss that’s disallowed because of the rules, a C corporation is a closely held corpora- certain extent) as a deduction against the dece- at-risk limits as a deduction from the same action if at any time during the last half of the tax dent's income in the year of death. The dece- tivity in the next tax year. If your losses from an year, more than 50% in value of its outstanding dent's losses are allowed only to the extent they at-risk activity are allowed, they’re subject to re- stock is owned directly or indirectly by or for five exceed the amount by which the transferee's capture in later years if your amount at risk is re- or fewer individuals. basis in the passive activity has been increased duced below zero. To figure if more than 50% in value of the under the rules for determining the basis of You must apply the at-risk rules before stock is owned by five or fewer individuals, ap- property acquired from a decedent. For exam- ! the passive activity rules discussed in ply the following rules. ple, if the basis of an interest in a passive activ- CAUTION the first part of this publication. 1. Stock owned directly or indirectly by or for ity in the hands of a transferee is increased by a corporation, partnership, estate, or trust $6,000 and unused passive activity losses of Loss defined. A loss is the excess of allowa- is considered owned proportionately by its $8,000 were allocable to the interest at the date ble deductions from the activity for the year (in- shareholders, partners, or beneficiaries. of death, then the decedent's deduction for the cluding depreciation or amortization allowed or tax year would be limited to $2,000 ($8,000 − 2. An individual is considered to own the allowable and disregarding the at-risk limits) $6,000). stock owned directly or indirectly by or for over income received or accrued from the activ- his or her family. Family includes only If you inherited property from a decedent ity during the year. Income doesn’t include in- who died in 2010, special rules may apply if the brothers and sisters (including half broth- come from the recapture of previous losses ers and half sisters), a spouse, ancestors, executor of the estate files Form 8939, Alloca- (discussed, later, under Recapture Rule). tion of Increase in Basis for Property Acquired and lineal descendants. From a Decedent. For more information, see Form 6198. Use Form 6198 to figure how Pub. 4895, Tax Treatment of Property Acquired much loss from an activity you can deduct.

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3. If a person holds an option to buy stock, apply to the holding of real property placed in a. One full-time employee whose serv- he or she is considered to be the owner of service before 1987. They also don’t apply to ices were in the active management that stock. the holding of an interest acquired before 1987 of the business, and in a pass-through entity engaged in holding real 4. When applying rule (1) or (2), stock con- b. Three full-time nonowner employees property placed in service before 1987. This ex- sidered owned by a person under rule (1) whose services were directly related ception doesn’t apply to holding mineral prop- or (3) is treated as actually owned by that to the business. A nonowner em- erty. person. Stock considered owned by an in- ployee is an employee who doesn’t dividual under rule (2) isn’t treated as Personal property and services that are inci- own more than 5% in value of the out- owned by the individual for again applying dental to making real property available as liv- standing stock of the corporation at rule (2) to consider another the owner of ing accommodations are included in the activity any time during the tax year. (The that stock. of holding real property. For example, making rules for constructive ownership of personal property, such as furniture, and serv- stock in section 318 of the Internal 5. Stock that may be considered owned by ices available when renting a hotel or motel Revenue Code apply. However, in ap- an individual under either rule (2) or (3) is room or a furnished apartment is considered in- plying these rules, an owner of 5% or considered owned by the individual under cidental to making real property available as liv- more, rather than 50% or more, of the rule (3). ing accommodations. value of a corporation's stock is considered to own a proportionate share Exception for equipment leasing by a Activities Covered of any stock owned by the corpora- closely held corporation. If a closely held tion.) by the At-Risk Rules corporation is actively engaged in equipment leasing, the equipment leasing is treated as a 2. Deductions due to the business that are If you’re involved in one of the following activi- separate activity not covered by the at-risk allowable to the corporation as business ties as a trade or business or for the production rules. A closely held corporation is actively en- expenses and as contributions to certain of income, you’re subject to the at-risk rules. gaged in equipment leasing if 50% or more of employee benefit plans for the tax year ex- 1. Holding, producing, or distributing motion its gross receipts for the tax year are from ceed 15% of the gross income from the picture films or video tapes. equipment leasing. Equipment leasing means business. the leasing, purchasing, servicing, and selling of 3. The business isn’t an excluded business. 2. Farming. equipment that’s section 1245 property. Generally, an excluded business means 3. Leasing section 1245 property, including However, equipment leasing doesn’t include equipment leasing as defined, earlier, un- personal property and certain other tangi- the leasing of master sound recordings and der Exception for equipment leasing by a ble property that’s depreciable or amortiz- similar contractual arrangements for tangible or closely held corporation, and any business able. See Section 1245 property, later. intangible assets associated with literary, artis- involving the use, exploitation, sale, lease, tic, or musical properties, such as books, litho- 4. Exploring for, or exploiting, oil and gas. or other disposition of master sound re- graphs of artwork, or musical tapes. A closely cordings, motion picture films, video 5. Exploring for, or exploiting, geothermal de- held corporation can’t exclude these leasing ac- tapes, or tangible or intangible assets as- posits (for wells started after September tivities from the at-risk rules nor count them as sociated with literary, artistic, musical, or 1978). equipment leasing for the gross receipts test. similar properties. 6. Any other activity not included in (1) The equipment leasing exclusion also isn’t available for leasing activities related to other through (5) that’s carried on as a trade or Separation of Activities business or for the production of income. at-risk activities, such as motion picture films and video tapes, farming, oil and gas proper- Generally, you treat your activity involving each ties, and geothermal deposits. For example, if a Section 1245 property. Section 1245 prop- film or video tape, item of leased section 1245 closely held corporation leases a video tape, it erty includes any property that is or has been property, farm, oil and gas property, or geother- can’t exclude this leasing activity from the subject to depreciation or amortization and is: mal property as a separate activity. In addition, at-risk rules under the equipment leasing exclu- each investment that isn’t a part of a trade or 1. Personal property, sion. business is treated as a separate activity. 2. Other tangible property (other than a build- Controlled group of corporations. A con- ing or its structural components) that’s: trolled group of corporations is subject to spe- Leasing by a partnership or S corporation. a. Used in manufacturing, production, cial rules for the equipment leasing exclusion. For a partnership or S corporation, treat all leas- extraction, or furnishing transporta- See section 465(c) of the Internal Revenue ing of section 1245 property that’s placed in tion, communications, electrical en- Code. service in any tax year of the partnership or S ergy, gas, water, or sewage disposal corporation as one activity. services, Special exception for qualified corporations. A qualified corporation isn’t subject to Aggregation of Activities b. A research facility used for the activi- the at-risk limits for any qualifying business car- ties in (a), or ried on by the corporation. Each qualifying busi- Activities described in (6) under Activities Cov- c. A facility used in any of the activities ness is treated as a separate activity. ered by the At-Risk Rules, earlier, that consti- in (a) for the bulk storage of fungible tute a trade or business are treated as one ac- Qualified corporation. A qualified corpo- commodities, tivity if: ration is a closely held C corporation, defined • You actively participate in the manage- 3. Real property (other than property descri- earlier, that isn’t: ment of the trade or business, or bed in (2)) with an adjusted basis that was • A personal holding company, or • The trade or business is carried on by a reduced by certain amortization deduc- • A personal service corporation (defined in partnership or S corporation and 65% or tions listed in section 1245(a)(3)(C) of the section 269A(b) of the Internal Revenue more of its losses for the tax year are allo- Internal Revenue Code, Code, but determined by substituting 5% cable to persons who actively participate in for 10%). 4. A single-purpose agricultural or horticul- the management of the trade or business. tural structure, or Qualifying business. A qualifying busi- Similar rules apply to activities described in (1) 5. A storage facility (other than a building or ness is any active business if all of the following through (5) of that earlier discussion. its structural components) used for the dis- apply. tribution of petroleum. 1. During the entire 12-month period ending Active participation. Active participation de- on the last day of the tax year, the corpo- pends on all the facts and circumstances. Fac- Exception for holding real property placed ration had at least: tors that indicate active participation include in service before 1987. The at-risk rules don’t making decisions involving the operation or

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management of the activity, performing serv- • Amounts borrowed from a person having brothers and half sisters, a spouse, ances- ices for the activity, and hiring and discharging an interest in the activity as a creditor, or tors, and lineal descendants. employees. Factors that indicate a lack of ac- • Amounts borrowed after May 3, 2004, se- 3. Any stock in a corporation owned by an in- tive participation include lack of control in man- cured by real property used in the activity dividual (other than by applying rule (2)) is aging and operating the activity, having author- of holding real property (other than mineral considered owned directly or indirectly by ity only to discharge the manager of the activity, property) that, if nonrecourse, would be the individual's partner. and having a manager of the activity who is an qualified nonrecourse financing. independent contractor rather than an em- 4. When applying rule (1), (2), or (3), stock ployee. Related persons. Related persons in- considered owned by a person under rule clude: (1) is treated as actually owned by that Partners and S corporation shareholders. • Members of a family, but only an individu- person. But, if a person constructively Partners or shareholders may aggregate activi- al's brothers and sisters, half brothers and owns stock because of rule (2) or (3), he ties of their partnership or S corporation within half sisters, spouse, ancestors (parents, or she doesn’t own the stock for purposes each of the following categories. grandparents, etc.), and lineal descend- of applying either rule (2) or (3) to make • Films and video tapes, ants (children, grandchildren, etc.); another person the constructive owner of • Farms, • Two corporations that are members of the the same stock. • Oil and gas properties, and same controlled group of corporations de- • Geothermal properties. termined by applying a 10% ownership Effect of government price support pro- test; grams. A government target price program or For example, if a partnership or S corpora- • The fiduciaries of two different trusts, or tion produces two films or video tapes, the part- other government price support programs for a the fiduciary and beneficiary of two differ- product that you grow doesn’t, without agree- ners or S corporation shareholders may treat ent trusts, if the same person is the grantor the production of both films or video tapes as ments limiting your costs, reduce the amount of both trusts; you have at risk. one activity for purposes of the at-risk rules. • A tax-exempt educational or charitable organization and a person who directly or in- Effect of increasing amounts at risk in sub- At-Risk Amounts directly controls it (or a member of whose sequent years. Any loss that’s allowable in a family controls it); particular year reduces your at-risk investment You’re at risk in any activity for: • A corporation and an individual who owns (but not below zero) as of the beginning of the directly or indirectly more than 10% of the next tax year and in all succeeding tax years for 1. The money and adjusted basis of property value of the outstanding stock of the cor- that activity. If you have a loss that’s more than you contribute to the activity, and poration; your at-risk amount, the loss disallowed won’t 2. Amounts you borrow for use in the activity • A trust fiduciary and a corporation of which be allowed in later years unless you increase if: more than 10% in value of the outstanding your at-risk amount. Losses that are suspended stock is owned directly or indirectly by or because they’re greater than your investment a. You’re personally liable for repay- for the trust or by or for the grantor of the that’s at risk are treated as a deduction for the ment, or trust; activity in the following year. Consequently, if b. You pledge property (other than prop- • The grantor and fiduciary, or the fiduciary your amount at risk increases in later years, you erty used in the activity) as security for and beneficiary, of any trust; may deduct previously suspended losses to the the loan. • A corporation and a partnership if the extent that the increases in your amount at risk same persons own more than 10% in value exceed your losses in later years. However, Amounts borrowed. You’re at risk for of the outstanding stock of the corporation your deduction of suspended losses may be amounts borrowed to use in the activity if you’re and more than 10% of the capital interest limited by the passive loss rules. personally liable for repayment. You’re also at or the profits interest in the partnership; risk if the amounts borrowed are secured by • Two S corporations if the same persons property other than property used in the activity. own more than 10% in value of the out- Amounts Not at Risk In this case, the amount considered at risk is standing stock of each corporation; You aren’t considered at risk for amounts pro- the net fair market value of your interest in the • An S corporation and a regular corporation tected against loss through nonrecourse financ- pledged property. The net fair market value of if the same persons own more than 10% in ing, guarantees, stop loss agreements, or other property is its fair market value (determined on value of the outstanding stock of each cor- similar arrangements. the date the property is pledged) less any prior poration; (or superior) claims to which it’s subject. How- • A partnership and a person who owns di- Nonrecourse financing. Nonrecourse financ- ever, no property will be taken into account as rectly or indirectly more than 10% of the ing is financing for which you aren’t personally security if it’s directly or indirectly financed by capital or profits of the partnership; liable. If you borrow money to contribute to an debt that’s secured by property you contributed • Two partnerships if the same persons di- activity and the lender's only recourse is to your to the activity. rectly or indirectly own more than 10% of the capital or profits of each; interest in the activity or the property used in the If you borrow money to finance a con- • Two persons who are engaged in business activity, the loan is a nonrecourse loan. ! tribution to an activity, you can’t in- under common control; and You aren’t considered at risk for your share CAUTION crease your amount at risk by the con- • An executor of an estate and a beneficiary of any nonrecourse loan used to finance an ac- tribution and the amount borrowed to finance of that estate. tivity or to acquire property used in the activity the contribution. You may increase your at-risk unless the loan is secured by property not used amount only once. To determine the direct or indirect owner- in the activity. ship of the outstanding stock of a corporation, However, you’re considered at risk for quali- apply the following rules. Certain borrowed amounts excluded. fied nonrecourse financing secured by real Even if you’re personally liable for the repay- 1. Stock owned directly or indirectly by or for property used in an activity of holding real prop- ment of a borrowed amount or you secure a a corporation, partnership, estate, or trust erty. Qualified nonrecourse financing is financ- borrowed amount with property other than prop- is considered owned proportionately by or ing for which no one is personally liable for re- erty used in the activity, you aren’t considered for its shareholders, partners, or beneficia- payment and that’s: at risk if you borrowed the money from a person ries. • Borrowed by you in connection with the ac- having an interest in the activity or from some- tivity of holding real property, 2. Stock owned directly or indirectly by or for one related to a person (other than you) having • Secured by real property used in the activ- an individual's family is considered owned an interest in the activity. This doesn’t apply to: ity, by the individual. The family of an individ- • Amounts borrowed by a corporation from a • Not convertible from a debt obligation to an ual includes only brothers and sisters, half person whose only interest in the activity is ownership interest, and as a shareholder of the corporation,

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• Loaned or guaranteed by any federal, against tort liability, it doesn’t affect the amount filing your return online or in your local commun- state, or local government, or borrowed by you’re otherwise considered to have at risk. ity, if you qualify, which include the following. you from a qualified person. • Free File. This program lets you prepare and file your federal individual income tax Other types of property used as secur- Reductions of return for free using brand-name tax-prep- ity. The rules in the next two paragraphs apply Amounts at Risk aration-and-filing software or Free File filla- to any financing incurred after August 3, 1998. ble forms. However, state tax preparation You can also choose to apply these rules to fi- The amount you have at risk in any activity is re- may not be available through Free File. Go nancing you obtained before August 4, 1998. If duced by any losses allowed in previous years to IRS.gov/FreeFile to see if you qualify for you do that, you must reduce the amounts at under the at-risk rules. It may also be reduced free online federal tax preparation, e-filing, risk as a result of applying these rules to years because of distributions you received from the and direct deposit or payment options. ending before August 4, 1998, to the extent activity, debts changed from recourse to nonre- • VITA. The Volunteer Income Tax Assis- they increase the losses allowed for those course, or the initiation of a stop loss or similar tance (VITA) program offers free tax help years. agreement. If the amount at risk is reduced be- to people with low-to-moderate incomes, In determining whether qualified nonre- low zero, your previously allowed losses are persons with disabilities, and limited-Eng- course financing is secured only by real prop- subject to recapture, as explained next. lish-speaking taxpayers who need help erty used in the activity of holding real property, preparing their own tax returns. Go to disregard property that’s incidental to the activ- IRS.gov/VITA, download the free IRS2Go ity of holding real property. Also disregard other Recapture Rule app, or call 800-906-9887 for information property if the total gross fair market value of on free tax return preparation. that property is less than 10% of the total gross If the amount you have at risk in any activity at • TCE. The Tax Counseling for the Elderly fair market value of all the property securing the the end of any tax year is less than zero, you (TCE) program offers free tax help for all financing. must recapture at least part of your previously taxpayers, particularly those who are 60 For this purpose, treat yourself as owning di- allowed losses. You do this by adding to your years of age and older. TCE volunteers rectly your proportional share of the assets in income from the activity for that year the lesser specialize in answering questions about any partnership in which you own, directly or in- of the following amounts. pensions and retirement-related issues directly, an equity interest. • The negative at-risk amount (treated as a unique to seniors. Go to IRS.gov/TCE, Qualified person. A qualified person is a positive amount); or download the free IRS2Go app, or call person who actively and regularly engages in • The total amount of losses deducted in 888-227-7669 for information on free tax the business of lending money. The most com- previous tax years beginning after 1978, return preparation. mon example is a bank. minus any amounts you previously added • MilTax. Members of the U.S. Armed However, none of the following persons can to your income from that activity under this Forces and qualified veterans may use Mil- be a qualified person. recapture rule. Tax, a free tax service offered by the De- • A person related to you in one of the ways partment of Defense through Military One- Don’t use the recapture income to reduce listed under Related persons, earlier. How- Source. any net loss from the activity for the tax year. In- ever, a person related to you may be a Also the IRS offers Free Fillable Forms, stead, treat the recaptured amount as a deduc- qualified person if the nonrecourse financ- which can be completed online and then tion for the activity in the next tax year. ing is commercially reasonable and on the filed electronically regardless of income. same terms as loans involving unrelated Pre-1979 activity. If the amount you had at persons. Using online tools to help prepare your re- risk in an activity at the end of your tax year that A person from which you acquired the turn. Go to IRS.gov/Tools for the following. • began in 1978 was less than zero, you apply property or a person related to that person. • The Earned Income Tax Credit Assistant the preceding rule for the recapture of losses by A person who receives a fee due to your (IRS.gov/EITCAssistant) determines if • substituting that negative amount for zero. For investment in the real property or a person you’re eligible for the earned income credit example, if your at-risk amount for that tax year related to that person. (EIC). was minus $50, you will recapture losses only • The Online EIN Application (IRS.gov/EIN) when your at-risk amount goes below minus Other loss limiting arrangements. Any capi- helps you get an employer identification $50. tal you have contributed to an activity isn’t at number (EIN). risk if you’re protected against economic loss by • The Tax Withholding Estimator (IRS.gov/ an agreement or arrangement for compensation W4app) makes it easier for everyone to or reimbursement. For example, you aren’t at How To Get Tax Help pay the correct amount of tax during the risk if you will be reimbursed for part or all of year. The tool is a convenient, online way any loss because of a binding agreement be- If you have questions about a tax issue, need to check and tailor your withholding. It’s tween yourself and another person. help preparing your tax return, or want to down- more user-friendly for taxpayers, including load free publications, forms, or instructions, go retirees and self-employed individuals. The Example 1. Some commercial feedlots re- to IRS.gov and find resources that can help you features include the following. imburse investors against any loss sustained on right away. – Easy to understand language. sales of the fed livestock above a stated dollar – The ability to switch between screens, amount per head. Under such stop loss orders, Preparing and filing your tax return. After correct previous entries, and skip the investor is at risk only for the portion of the receiving all your wage and earnings state- screens that don’t apply. investor's capital for which the investor isn’t en- ments (Form W-2, W-2G, 1099-R, 1099-MISC, – Tips and links to help you determine if titled to a reimbursement. 1099-NEC, etc.); unemployment compensation you qualify for tax credits and deduc- statements (by mail or in a digital format) or tions. Example 2. You’re personally liable for a other government payment statements (Form – A progress tracker. mortgage, but you separately obtain insurance 1099-G); and interest, dividend, and retirement – A self-employment tax feature. to compensate you for any payments you must statements from banks and investment firms – Automatic calculation of taxable social actually make because of your personal liability. (Forms 1099), you have several options to security benefits. choose from to prepare and file your tax return. You’re considered at risk only to the extent of The First Time Homebuyer Credit Account You can prepare the tax return yourself, see if • the uninsured portion of the personal liability to Look-up (IRS.gov/HomeBuyer) tool pro- you qualify for free tax preparation, or hire a tax which you’re exposed. You can include in the vides information on your repayments and professional to prepare your return. amount you have at risk the amount of any pre- account balance. mium which you paid from your personal assets Free options for tax preparation. Go to • The Sales Tax Deduction Calculator for the insurance. However, if you obtain casu- (IRS.gov/SalesTax) figures the amount you alty insurance or insurance protecting yourself IRS.gov to see your options for preparing and

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can claim if you itemize deductions on sites. Always protect your identity when using calls, or social media channels to request Schedule A (Form 1040). any social networking site. personal or financial information. This includes requests for personal identification Getting answers to your tax ques- The following IRS YouTube channels pro- numbers (PINs), passwords, or similar in- tions. On IRS.gov, you can get vide short, informative videos on various tax-re- formation for credit cards, banks, or other up-to-date information on current lated topics in English, Spanish, and ASL. financial accounts. events and changes in tax law. • Youtube.com/irsvideos. • Youtube.com/irsvideosmultilingua. • Go to IRS.gov/IdentityTheft, the IRS Iden- • IRS.gov/Help: A variety of tools to help you • Youtube.com/irsvideosASL. tity Theft Central webpage, for information get answers to some of the most common on identity theft and data security protec- tax questions. Watching IRS videos. The IRS Video portal tion for taxpayers, tax professionals, and • IRS.gov/ITA: The Interactive Tax Assistant, (IRSVideos.gov) contains video and audio pre- businesses. If your SSN has been lost or a tool that will ask you questions on a num- sentations for individuals, small businesses, stolen or you suspect you’re a victim of ber of tax law topics and provide answers. and tax professionals. tax-related identity theft, you can learn • IRS.gov/Forms: Find forms, instructions, what steps you should take. and publications. You will find details on Online tax information in other languages. • Get an Identity Protection PIN (IP PIN). IP 2020 tax changes and hundreds of interac- You can find information on IRS.gov/ PINs are six-digit numbers assigned to eli- tive links to help you find answers to your MyLanguage if English isn’t your native lan- gible taxpayers to help prevent the misuse questions. guage. of their SSNs on fraudulent federal income • You may also be able to access tax law in- tax returns. When you have an IP PIN, it formation in your electronic filing software. Free interpreter service. Multilingual assis- prevents someone else from filing a tax re- tance, provided by the IRS, is available at Tax- turn with your SSN. To learn more, go to payer Assistance Centers (TACs) and other IRS.gov/IPPIN. Need someone to prepare your tax return? IRS offices. Over-the-phone interpreter service There are various types of tax return preparers, is accessible in more than 350 languages. Checking on the status of your refund. including tax preparers, enrolled agents, certi- • Go to IRS.gov/Refunds. fied public accountants (CPAs), attorneys, and Getting tax forms and publications. Go to • The IRS can’t issue refunds before many others who don’t have professional cre- IRS.gov/Forms to view, download, or print all of mid-February 2021 for returns that claimed dentials. If you choose to have someone pre- the forms, instructions, and publications you the EIC or the additional child tax credit pare your tax return, choose that preparer may need. You can also download and view (ACTC). This applies to the entire refund, wisely. A paid tax preparer is: popular tax publications and instructions (in- not just the portion associated with these • Primarily responsible for the overall sub- cluding the Instructions for Forms 1040 and credits. stantive accuracy of your return, 1040-SR) on mobile devices as an eBook at • Download the official IRS2Go app to your • Required to sign the return, and IRS.gov/eBooks. Or you can go to IRS.gov/ mobile device to check your refund status. • Required to include their preparer tax iden- OrderForms to place an order. • Call the automated refund hotline at tification number (PTIN). 800-829-1954. Access your online account (individual tax- Although the tax preparer always signs the payers only). Go to IRS.gov/Account to se- Making a tax payment. The IRS uses the lat- return, you're ultimately responsible for provid- curely access information about your federal tax est encryption technology to ensure your elec- ing all the information required for the preparer account. tronic payments are safe and secure. You can to accurately prepare your return. Anyone paid • View the amount you owe, pay online, or make electronic payments online, by phone, to prepare tax returns for others should have a set up an online payment agreement. and from a mobile device using the IRS2Go thorough understanding of tax matters. For • Access your tax records online. app. Paying electronically is quick, easy, and more information on how to choose a tax pre- • Review your payment history. faster than mailing in a check or money order. parer, go to Tips for Choosing a Tax Preparer • Go to IRS.gov/SecureAccess to review the Go to IRS.gov/Payments for information on how on IRS.gov. required identity authentication process. to make a payment using any of the following options. Coronavirus. Go to IRS.gov/Coronavirus for Using direct deposit. The fastest way to re- • IRS Direct Pay: Pay your individual tax bill links to information on the impact of the corona- ceive a tax refund is to file electronically and or estimated tax payment directly from virus, as well as tax relief available for individu- choose direct deposit, which securely and elec- your checking or savings account at no als and families, small and large businesses, tronically transfers your refund directly into your cost to you. and tax-exempt organizations. financial account. Direct deposit also avoids the • Debit or Credit Card: Choose an approved possibility that your check could be lost, stolen, payment processor to pay online, by Tax reform. Tax reform legislation affects indi- or returned undeliverable to the IRS. Eight in 10 phone, or by mobile device. viduals, businesses, and tax-exempt and gov- taxpayers use direct deposit to receive their re- • Electronic Funds Withdrawal: Offered only ernment entities. Go to IRS.gov/TaxReform for funds. The IRS issues more than 90% of re- when filing your federal taxes using tax re- information and updates on how this legislation funds in less than 21 days. turn preparation software or through a tax affects your taxes. professional. Getting a transcript of your return. The • Electronic Federal Tax Payment System: Employers can register to use Business quickest way to get a copy of your tax transcript Best option for businesses. Enrollment is Services Online. The Social Security Adminis- is to go to IRS.gov/Transcripts. Click on either required. tration (SSA) offers online service at SSA.gov/ “Get Transcript Online” or “Get Transcript by • Check or Money Order: Mail your payment employer for fast, free, and secure online W-2 Mail” to order a free copy of your transcript. If to the address listed on the notice or in- filing options to CPAs, accountants, enrolled you prefer, you can order your transcript by call- structions. agents, and individuals who process Form W-2, ing 800-908-9946. • Cash: You may be able to pay your taxes Wage and Tax Statement, and Form W-2c, with cash at a participating retail store. Corrected Wage and Tax Statement. Reporting and resolving your tax-related • Same-Day Wire: You may be able to do identity theft issues. same-day wire from your financial institu- IRS social media. Go to IRS.gov/SocialMedia • Tax-related identity theft happens when tion. Contact your financial institution for to see the various social media tools the IRS someone steals your personal information availability, cost, and cut-off times. uses to share the latest information on tax to commit tax fraud. Your taxes can be af- changes, scam alerts, initiatives, products, and fected if your SSN is used to file a fraudu- services. At the IRS, privacy and security are lent return or to claim a refund or credit. paramount. We use these tools to share public information with you. Don’t post your SSN or • The IRS doesn’t initiate contact with tax- other confidential information on social media payers by email, text messages, telephone

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What if I can’t pay now? Go to IRS.gov/ so you’ll know in advance that you can get the • You’ve tried repeatedly to contact the IRS Payments for more information about your op- service you need without long wait times. Be- but no one has responded, or the IRS tions. fore you visit, go to IRS.gov/TACLocator to find hasn’t responded by the date promised. • Apply for an online payment agreement the nearest TAC and to check hours, available (IRS.gov/OPA) to meet your tax obligation services, and appointment options. Or, on the How Can You Reach TAS? in monthly installments if you can’t pay IRS2Go app, under the Stay Connected tab, your taxes in full today. Once you complete choose the Contact Us option and click on “Lo- TAS has offices in every state, the District of the online process, you will receive imme- cal Offices.” Columbia, and Puerto Rico. Your local advo- diate notification of whether your agree- cate’s number is in your local directory and at ment has been approved. The Taxpayer Advocate TaxpayerAdvocate.IRS.gov/Contact-Us. You • Use the Offer in Compromise Pre-Qualifier can also call them at 877-777-4778. to see if you can settle your tax debt for Service (TAS) Is Here To less than the full amount you owe. For Help You more information on the Offer in Compro- How Else Does TAS Help mise program, go to IRS.gov/OIC. What Is TAS? Taxpayers? TAS is an independent organization within the Filing an amended return. You can now file TAS works to resolve large-scale problems that IRS that helps taxpayers and protects taxpayer Form 1040-X electronically with tax filing soft- affect many taxpayers. If you know of one of rights. Their job is to ensure that every taxpayer ware to amend 2019 Forms 1040 and 1040-SR. these broad issues, please report it to them at is treated fairly and that you know and under- To do so, you must have e-filed your original IRS.gov/SAMS. stand your rights under the Taxpayer Bill of 2019 return. Amended returns for all prior-years Rights. must be mailed. See Tips for taxpayers who TAS for Tax Professionals need to file an amended tax return and go to IRS.gov/Form1040X for information and up- How Can You Learn About Your TAS can provide a variety of information for tax dates. Taxpayer Rights? professionals, including tax law updates and guidance, TAS programs, and ways to let TAS Checking the status of your amended re- The Taxpayer Bill of Rights describes 10 basic know about systemic problems you’ve seen in turn. Go to IRS.gov/WMAR to track the status rights that all taxpayers have when dealing with your practice. of Form 1040-X amended returns. Please note the IRS. Go to TaxpayerAdvocate.IRS.gov to that it can take up to 3 weeks from the date you help you understand what these rights mean to Low Income Taxpayer filed your amended return for it to show up in you and how they apply. These are your rights. our system, and processing it can take up to 16 Know them. Use them. Clinics (LITCs) weeks. What Can TAS Do For You? LITCs are independent from the IRS. LITCs Understanding an IRS notice or letter represent individuals whose income is below a certain level and need to resolve tax problems you’ve received. Go to IRS.gov/Notices to TAS can help you resolve problems that you with the IRS, such as audits, appeals, and tax find additional information about responding to can’t resolve with the IRS. And their service is collection disputes. In addition, clinics can pro- an IRS notice or letter. free. If you qualify for their assistance, you will vide information about taxpayer rights and re- be assigned to one advocate who will work with sponsibilities in different languages for individu- Contacting your local IRS office. Keep in you throughout the process and will do every- als who speak English as a second language. mind, many questions can be answered on thing possible to resolve your issue. TAS can Services are offered for free or a small fee for IRS.gov without visiting an IRS Taxpayer Assis- help you if: eligible taxpayers. To find a clinic near you, visit tance Center (TAC). Go to IRS.gov/LetUsHelp • Your problem is causing financial difficulty www.TaxpayerAdvocate.IRS.gov/about-us/ for the topics people ask about most. If you still for you, your family, or your business; Low-Income-Taxpayer-Clinics-LITC/ or see IRS need help, IRS TACs provide tax help when a • You face (or your business is facing) an Pub. 4134, Low Income Taxpayer Clinic List. tax issue can’t be handled online or by phone. immediate threat of adverse action; or All TACs now provide service by appointment,

To help us develop a more useful index, please let us know if you have ideas for index entries. Index See “Comments and Suggestions” in the “Introduction” for the ways you can reach us.

Loss defined 12 Corporations: A Partners 12 Closely held 6, 10 F Active participation 13 S corporation shareholders 12 Controlled group of 13 Farmer 6 Activity: Who is affected 12 Personal service 6, 10 Farm loss 3 Appropriate economic unit 8 At-risk rules: Qualified 13 Form: Nonpassive 5 Activities covered by 13 CRD 4 6198 12 Trade or business 3 Exceptions to 13 8810 2 Amounts borrowed 14 Excluded business 13 Former passive activity 3 Amounts not at risk 14, 15 Qualified corporation 13 D Appropriate economic unit 8 Qualifying business 13 Deductions, passive activity 7 Assistance (See Tax help) Recapture rule 15 Disabled farmer 6 G At-risk activities: Disclosure requirement 9 Grouping passive activities 8 Aggregation of 13 Dispositions: Separation of 13 B Death 12 At-risk amounts 14 Borrowed amounts 14 Gift 12 I Government price support Installment sale 12 Income, passive activity 6 programs 14 Partial 9 Increasing amounts 14 C Nonrecourse financing 14 Closely held corporation 12 L At-risk limits 12 Commercial revitalization E Limited entrepreneur 9 Closely held corporation 12 deduction 4 Excluded business, definition Limited partners 6 of 13

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Material participation 5 Self-charged interest 6 M Rental 3 R Separate activity 13 Material participation 5, 6 Rules 3, 8 Real estate professional 6 Significant participation passive Modified adjusted gross Who must use these rules 2 Recapture rule under at-risk activities 10 income 4 Passive activity deductions 7 limits 15 Special $25,000 allowance 4 Passive activity income 6 Recharacterization of passive Surviving spouse of farmer 6 Passive income, income 10 N recharacterization of 10 Reductions of amounts at Nonrecourse loan 14 Publications (See Tax help) risk 15 T Publicly traded partnership 3, 9 Related persons 14 Tax help 15 Rental activity: Trade or business activities: P $25,000 offset 4 Definition of 3 Participation 5 Q Active participation 4 Real property 6 Active 13 Qualified person, nonrecourse Exceptions 3 Material 5 financing 15 Phaseout rule 4 Passive activity 2, 12 Qualifying business, at-risk Real estate professional 6 W Disposition 11 rules 13 Retired farmer 6 Worksheet A 10 Former 3 Worksheet B 10, 11 Grouping 8 Limits 2 S Section 1245 property 13

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