Passive Activity and At-Risk Rules

Publication 925
               Cat. No. 64265X                                                   Contents

               Passive Activity
                                                                                 Future Developments . . . . . . . . . . . . 1
Department
of the                                                                           Reminders . . . . . . . . . . . . . . . . . . . 1


               and
Treasury
Internal                                                                         Introduction . . . . . . . . . . . . . . . . . . 2
Revenue

               At-Risk Rules
Service                                                                          Passive Activity Limits . . . . .       ...... 2
                                                                                     Who Must Use These Rules?           ...... 2
                                                                                     Passive Activities . . . . . . .    ...... 3
                                                                                     Activities That Aren’t Passive
                                                                                        Activities . . . . . . . . . .   ...... 5
                                                                                     Passive Activity Income and
               For use in preparing                                                     Deductions . . . . . . . .       ...... 6
                                                                                     Grouping Your Activities . . .      ...... 8

               2018 Returns                                                          Recharacterization of Passive
                                                                                        Income . . . . . . . . . .
                                                                                     Dispositions . . . . . . . . . .
                                                                                                                         . . . . . 10
                                                                                                                         . . . . . 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
                                                                                 Publication 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 inclu-
                                                                                      ded in (6) under Activities Covered by the
                                                                                      At-Risk Rules and you have borrowed cer-
                                                                                      tain amounts described in Certain bor-
                                                                                      rowed 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 activ-
                                                                                      ity of holding real property (other than min-
                                                                                      eral property) that, if nonrecourse, would
                Get forms and other information faster and easier at:
                • IRS.gov (English)           • IRS.gov/Korean (한국어)                  be qualified nonrecourse financing.
                • IRS.gov/Spanish (Español)   • IRS.gov/Russian (Pусский)        Photographs of missing children. The Inter-
                • IRS.gov/Chinese (中文)        • IRS.gov/Vietnamese (TiếngViệt)   nal Revenue Service is a proud partner with the
                                                                                 National Center for Missing & Exploited


Jan 28, 2019
Children® (NCMEC). Photographs of missing                                                                      2. The sum of the losses for the tax year from
children selected by the Center may appear in
this publication on pages that would otherwise      Passive Activity Limits                                       all activities having losses for the tax year.

be blank. You can help bring these children                                                                  Use Worksheet 5 of Form 8582 to figure the rat-
                                                                                                             able portion of the loss from each activity that’s
home by looking at the photographs and calling
1-800-THE-LOST (1-800-843-5678) if you rec-
                                                    Who Must Use These Rules?                                disallowed.
ognize a child.                                                                                                 Loss from an activity. The term “loss from
                                                    The passive activity rules apply to:
                                                                                                             an activity” means:
                                                     • Individuals,
Introduction                                         • Estates,                                                1. The amount by which the passive activity
This publication discusses two sets of rules that
                                                     • Trusts (other than grantor trusts),                        deductions (defined later) from the activity
may limit the amount of your deductible loss
                                                     • Personal service corporations, and                         for the tax year exceed the passive activity
from a trade, business, rental, or other in-
                                                     • Closely held corporations.                                 gross income (defined later) from the ac-
                                                                                                                  tivity for the tax year; reduced by
come-producing activity. The first part of the          Even though the rules don’t apply to grantor
publication discusses the passive activity rules.   trusts, partnerships, and S corporations directly,         2. Any part of such amount that’s allowed un-
The second part discusses the at-risk rules.        they do apply to the owners of these entities.                der the Special $25,000 allowance, later.
However, when you figure your allowable los-
ses from any activity, you must apply the at-risk                                                                If your passive activity gross income from
                                                        For information about personal service cor-          significant participation passive activities (de-
rules before the passive activity rules.            porations and closely held corporations, includ-         fined later) for the tax year is more than your
                                                    ing definitions and how the passive activity             passive activity deductions from those activities
Comments and suggestions. We welcome                rules apply to these corporations, see Form              for the tax year, those activities shall be treated,
your comments about this publication and your       8810 and its instructions.                               solely for purposes of figuring your loss from the
suggestions for future editions.
   You can send us comments through                          Before applying the passive activity            activity, as a single activity that doesn’t have a
                                                             limits, you must first determine the            loss for such taxable year. See Significant Par-
IRS.gov/FormComments. Or you can write to:             !
                                                    CAUTION amount of the deductions disallowed              ticipation Passive Activities, later.
     Internal Revenue Service                       under the basis, excess farm loss, or at-risk
     Tax Forms and Publications                     rules. See Passive Activity Deductions, later.              Example. John Pine holds interests in three
     1111 Constitution Ave. NW, IR-6526                                                                      passive activities, A, B, and C. The gross in-
     Washington, DC 20224                                                                                    come and deductions from these activities for
                                                    Passive Activity Loss                                    the taxable year are as follows.
    Although we can’t respond individually to
each comment received, we do appreciate your        Generally, the passive activity loss for the tax                          A          B         C         Total
feedback and will consider your comments as         year isn’t allowed. However, there is a special
we revise our tax forms, instructions, and publi-   allowance under which some or all of your pas-            Gross
cations.                                            sive activity loss may be allowed. See Special            income       $7,000     $4,000     $12,000   $23,000
                                                    $25,000 allowance, later.
    Ordering forms and publications. Visit                                                                    Deductions   (16,000)   (20,000)   (8,000)   (44,000)
IRS.gov/FormsPubs to download forms and             Definition of passive activity loss. Gener-
publications. Otherwise, you can go to IRS.gov/     ally, your passive activity loss for the tax year is
OrderForms to order current and prior-year          the excess of your passive activity deductions            Net
forms and instructions. Your order should arrive    over your passive activity gross income. See              income
                                                                                                              (loss)       ($9,000) ($16,000)    $4,000    ($21,000)
within 10 business days.                            Passive Activity Income and Deductions, later.
    Tax questions. If you have a tax question           For a closely held corporation, the passive              John Pine’s $21,000 passive activity loss for
not answered by this publication, check             activity loss is the excess of passive activity de-      the taxable year is disallowed. Therefore, a rat-
IRS.gov and How To Get Tax Help at the end of       ductions over the sum of passive activity gross          able portion of the losses from activities A and
this publication.                                   income and net active income. For details on             B is disallowed. He figures the disallowed por-
                                                    net active income, see the Instructions for Form         tion of each loss as follows.
                                                    8810. For the definition of passive activity gross
Useful Items                                        income, see Passive Activity Income, later. For
You may want to see:                                the definition of passive activity deductions, see        A: $21,000 x $9,000/$25,000              $7,560
                                                    Passive Activity Deductions, later.                       B: $21,000 x $16,000/$25,000             13,440
  Publication
                                                                                                                           Total                       $21,000
     527 Residential Rental Property                Identification of Disallowed
                                                    Passive Activity Deductions
          527




         (Including Rental of Vacation Homes)
     541 Partnerships                                                                                        Allocation within loss activities. If all or any
                                                    If all or a part of your passive activity loss is dis-   part of your loss from an activity is disallowed
          541




  Form (and Instructions)                           allowed for the tax year, you may need to allo-          under Allocation of disallowed passive activity
                                                    cate the disallowed passive activity loss among          loss among activities for the tax year, a ratable
     4952 Investment Interest Expense               different passive activities and among different         portion of each of your passive activity deduc-
                4952




         Deduction                                  deductions within a passive activity.                    tions (defined later), other than an excluded de-
     6198 At-Risk Limitations
                6198




                                                                                                             duction (defined below) from such activity is
     8582 Passive Activity Loss Limitations         Allocation of disallowed passive activity                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




     8582-CR Passive Activity Credit                passive activity loss is disallowed for the tax          portion of the loss from the activity for the tax
                       8582-CR




         Limitations                                year, a ratable portion of the loss (if any) from        year multiplied by the fraction obtained by divid-
     8810 Corporate Passive Activity Loss and
                8810
                                                    each of your passive activities is disallowed.           ing:
         Credit Limitations                         The ratable portion of a loss from an activity is
                                                    computed by multiplying the passive activity               1. The amount of such deduction; by
     8949 Sales and Other Dispositions of
                                                    loss that’s disallowed for the tax year by the             2. The sum of all of your passive activity de-
                8949




         Capital Assets
                                                    fraction obtained by dividing:                                ductions (other than excluded deductions)
See How To Get Tax Help at the end of this                                                                        from that activity from the tax year.
publication for information about getting these       1. The loss from the activity for the tax year;
publications and forms.                                  by

Page 2                                                                                                                                  Publication 925 (2018)
Excluded deductions. “Excluded deduc-             held through a publicly traded partnership                     Revenue Code section 174 (or that would
tion” means any passive activity deduction            (PTP). You also must apply the limit on passive                be deductible if you chose to deduct rather
that’s taken into account in computing your net       activity credits separately to your credits from a             than capitalize them).
income from an item of property for a taxable         passive activity held through a PTP.                      A trade or business activity doesn’t include a
year in which an amount of the taxpayer's gross            You can offset deductions from passive ac-           rental activity or the rental of property that’s inci-
income from such item of property is treated as       tivities of a PTP only against income or gain             dental to an activity of holding the property for
not from a passive activity. See Recharacteriza-      from passive activities of the same PTP. Like-            investment.
tion of Passive Income, later.                        wise, you can offset credits from passive activi-
    Separately identified deductions. In              ties of a PTP only against the tax on the net                 You generally report trade or business activ-
identifying the deductions from an activity that      passive income from the same PTP. This sepa-              ities on Schedule C, C-EZ, F, or in Part II or III of
are disallowed, you don’t need to account sepa-       rate treatment rule also applies to a regulated           Schedule E.
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.
                                                                                                                Rental Activities
an income tax liability for any tax year different       For more information on how to apply the
from that which would result were such deduc-         passive activity loss rules to PTPs, and on how           A rental activity is a passive activity even if you
tion not taken into account separately.               to apply the limit on passive activity credits to         materially participated in that activity, unless
    Use Form 8582, Worksheet 7, for any activ-        PTPs, see Publicly Traded Partnerships (PTPs)             you materially participated as a real estate pro-
ity if you have passive activity deductions for       in the Instructions for Forms 8582 and                    fessional. See Real Estate Professional under
that activity that must be separately identified.     8582-CR, respectively.                                    Activities That Aren’t Passive Activities, later.
    Deductions that must be accounted for sep-                                                                  An activity is a rental activity if tangible property
arately include (but aren’t limited to) the follow-
ing deductions.                                       Excess Farm Loss                                          (real or personal) is used by customers or held
                                                                                                                for use by customers, and the gross income (or
   • Deductions that arise in a rental real estate                                                              expected gross income) from the activity repre-
                                                      If you have an excess farm loss for the tax year,
      activity in tax years in which you actively                                                               sents amounts paid (or to be paid) mainly for
                                                      special rules may apply. These rules don’t ap-
      participate in such activity. See Active par-                                                             the use of the property. It doesn’t matter
                                                      ply to C corporations. For information on excess
      ticipation, later.                                                                                        whether the use is under a lease, a service con-
                                                      farm losses, see the Instructions for Schedule F
   • Deductions that arise in a rental real estate                                                              tract, or some other arrangement.
                                                      (Form 1040), Profit or Loss From Farming.
      activity in tax years in which you don’t ac-
      tively participate in such activity. See Ac-                                                              Exceptions. Your activity isn’t a rental activity
      tive participation, later.                      Passive Activities                                        if any of the following apply.
   • Losses from sales or exchanges of capital
      assets.                                         There are two kinds of passive activities.                  1. The average period of customer use of the
   • Section 1231 losses. See Section 1231             • Trade or business activities in which you                   property is 7 days or less. You figure the
      Gains and Losses in Pub. 544, Sales and             don’t materially participate during the year.              average period of customer use by divid-
      Other Disposition of Assets, for more infor-     • Rental activities, even if you do materially                ing the total number of days in all rental
      mation.                                             participate in them, unless you’re a real es-              periods by the number of rentals during
                                                          tate professional.                                         the tax year. If the activity involves renting
                                                                                                                     more than one class of property, multiply
Carryover of Disallowed                               Material participation in a trade or business is               the average period of customer use of
Deductions                                            discussed later, under Activities That Aren’t                  each class by a fraction. The numerator of
                                                      Passive Activities.                                            the fraction is the gross rental income from
In the case of an activity with respect to which
                                                                                                                     that class of property and the denominator
any deductions or credits are disallowed for a        Treatment of former passive activities. A                      is the activity's total gross rental income.
taxable year (the loss activity), the disallowed      former passive activity is an activity that was a              The activity's average period of customer
deductions are allocated among your activities        passive activity in any earlier tax year, but isn’t a          use will equal the sum of the amounts for
for the next tax year in a manner that reasona-       passive activity in the current tax year. You can              each class.
bly reflects the extent to which each activity        deduct a prior year's unallowed loss from the
continues the loss activity. The disallowed de-       activity up to the amount of your current year              2. The average period of customer use of the
ductions or credits allocated to an activity under    net income from the activity. Treat any remain-                property, as figured in (1) above, is 30
the preceding sentence are treated as deduc-          ing prior year unallowed loss like you treat any               days or less and you provide significant
tions or credits from the activity for the next tax   other passive loss.                                            personal services with the rentals. Signifi-
year. For more information, see Regulations               In addition, any prior year unallowed passive              cant personal services include only serv-
section 1.469-1(f)(4).                                activity credits from a former passive activity                ices performed by individuals. To deter-
                                                      offset the allocable part of your current year tax             mine if personal services are significant,
                                                                                                                     all relevant facts and circumstances are
Passive Activity Credit                               liability. The allocable part of your current year
                                                                                                                     taken into consideration, including the fre-
                                                      tax liability is that part of this year's tax liability
                                                      that‘s allocable to the current year net income                quency of the services, the type and
Generally, the passive activity credit for the tax                                                                   amount of labor required to perform the
year is disallowed.                                   from the former passive activity. You figure this
                                                      after you reduce your net income from the activ-               services, and the value of the services rel-
    The passive activity credit is the amount by      ity by any prior year unallowed loss from that                 ative to the amount charged for use of the
which the sum of all your credits subject to the      activity (but not below zero).                                 property. Significant personal services
passive activity rules exceed your regular tax li-                                                                   don’t include the following.
ability allocable to all passive activities for the   Trade or Business Activities                                     a. Services needed to permit the lawful
tax year. Credits that are included in figuring the                                                                       use of the property,
general business credit are subject to the pas-       A trade or business activity is an activity that:
sive activity rules.                                                                                                   b. Services to repair or improve property
                                                       • Involves the conduct of a trade or business                      that would extend its useful life for a
                                                           (that is, deductions would be allowable un-
  See the Instructions for Form 8582-CR for                                                                               period substantially longer than the
                                                           der section 162 of the Internal Revenue
more information.                                                                                                         average rental, and
                                                           Code if other limitations, such as the pas-
                                                           sive activity rules, didn’t apply),                         c. Services that are similar to those
Publicly Traded Partnership                            • Is conducted in anticipation of starting a                       commonly provided with long-term
                                                           trade or business, or                                          rentals of real estate, such as clean-
You must apply the rules in this part separately       • Involves research or experimental expen-                         ing and maintenance of common
to your income or loss from a passive activity             ditures that are deductible under Internal                     areas or routine repairs.

Publication 925 (2018)                                                                                                                                       Page 3
3. You provide extraordinary personal serv-          to reduce your nonpassive income or tax on                Active participation isn’t required to take the
    ices in making the rental property available      nonpassive income.                                    low-income housing credit, the rehabilitation in-
    for customer use. Services are extraordi-             The maximum special allowance is reduced          vestment credit, or CRD from rental real estate
    nary personal services if they’re performed       if your modified adjusted gross income exceeds        activities.
    by individuals and the customers' use of          certain amounts. See Phaseout rule, later.
    the property is incidental to their receipt of                                                              Example. Mike, a single taxpayer, had the
    the services.                                         Example. Kate, a single taxpayer, has             following income and loss during the tax year.
                                                      $70,000 in wages, $15,000 income from a limi-
 4. The rental is incidental to a nonrental ac-
                                                      ted partnership, a $26,000 loss from rental real       Salary . . . . . . . . . . . . . . . . . . . . . . . . .     $42,300
    tivity. The rental of property is incidental to
                                                      estate activities in which she actively participa-     Dividends . . . . . . . . . . . . . . . . . . . . . . .           300
    an activity of holding property for invest-
                                                      ted, and isn’t subject to the modified adjusted        Interest . . . . . . . . . . . . . . . . . . . . . . . . .      1,400
    ment if the main purpose of holding the                                                                  Rental loss . . . . . . . . . . . . . . . . . . . . . .        (4,000)
                                                      gross income phaseout rule. She can use
    property is to realize a gain from its appre-
                                                      $15,000 of her $26,000 loss to offset her
    ciation and the gross rental income from                                                                    The rental loss came from a house Mike
                                                      $15,000 passive income from the partnership.
    the property is less than 2% of the smaller                                                             owned. He advertised and rented the house to
                                                      She actively participated in her rental real es-
    of the property's unadjusted basis or fair                                                              the current tenant himself. He also collected the
                                                      tate activities, so she can use the remaining
    market value. The unadjusted basis of                                                                   rents and did the repairs or hired someone to
                                                      $11,000 rental real estate loss to offset $11,000
    property is its cost not reduced by depreci-                                                            do them.
                                                      of her nonpassive income (wages).
    ation or any other basis adjustment. The                                                                    Even though the rental loss is a loss from a
    rental of property is incidental to a trade or        Commercial revitalization deduction               passive activity, Mike can use the entire $4,000
    business activity if all of the following ap-     (CRD). The special allowance must first be            loss to offset his other income because he ac-
    ply.                                              applied to losses from rental real estate activi-     tively participated.
      a. You own an interest in the trade or          ties figured without the CRD. Any remaining
                                                      part of the special allowance is available for the         Phaseout rule. The maximum special al-
         business activity during the year.                                                                 lowance of $25,000 ($12,500 for married indi-
                                                      CRD from the rental real estate activities and
      b. The rental property was used mainly          isn’t subject to the active participation rules or    viduals filing separate returns and living apart at
         in that trade or business activity dur-      the phaseout based on modified adjusted gross         all times during the year) is reduced by 50% of
         ing the current year, or during at least     income.                                               the amount of your modified adjusted gross in-
         2 of the 5 preceding tax years.                                                                    come that’s more than $100,000 ($50,000 if
                                                                You can’t claim a CRD for a building        you’re married filing separately). If your modi-
      c. Your gross rental income from the                      placed in service after December 31,        fied adjusted gross income is $150,000 or more
         property is less than 2% of the smaller
                                                         !
                                                      CAUTION   2009.                                       ($75,000 or more if you’re married filing sepa-
         of its unadjusted basis or fair market                                                             rately), you generally can’t use the special al-
         value. Lodging provided to an em-                Active participation. Active participation        lowance. This is because the special allowance
         ployee or the employee's spouse or           isn’t the same as material participation (defined     is reduced to $0 since the modified adjusted
         dependents is incidental to the activity     later). Active participation is a less stringent      gross income is over the $100,000 amount.
         or activities in which the employee          standard than material participation. For exam-            Modified adjusted gross income for this pur-
         performs services if the lodging is fur-     ple, you may be treated as actively participating     pose is your adjusted gross income figured
         nished for the employer's conven-            if you make management decisions in a signifi-        without the following.
         ience.                                       cant and bona fide sense. Management deci-              • Taxable social security and tier 1 railroad
 5. You customarily make the rental property          sions that count as active participation include            retirement benefits.
    available during defined business hours           approving new tenants, deciding on rental               • Deductible contributions to individual re-
    for nonexclusive use by various custom-           terms, approving expenditures, and similar de-              tirement accounts (IRAs) and section
    ers.                                              cisions.                                                    501(c)(18) pension plans.
                                                          Only individuals can actively participate in        • The exclusion from income of interest from
 6. You provide the property for use in a non-        rental real estate activities. However, a dece-             qualified U.S. savings bonds used to pay
    rental activity in your capacity as an owner      dent's estate is treated as actively participating          qualified higher education expenses.
    of an interest in the partnership, S corpo-       for its tax years ending less than 2 years after        • The exclusion from income of amounts re-
    ration, or joint venture conducting that ac-      the decedent's death, if the decedent would                 ceived from an employer's adoption assis-
    tivity.                                           have satisfied the active participation require-            tance program.
         If you meet any of the exceptions listed     ment for the activity for the tax year the dece-        • Passive activity income or loss included on
                                                      dent died.                                                  Form 8582.
 TIP above, see the Instructions for Form
         8582 for information about how to re-            A decedent's qualified revocable trust can          • Any rental real estate loss allowed be-
port any income or loss from the activity.            also be treated as actively participating if both           cause you materially participated in the
                                                      the trustee and the executor (if any) of the es-            rental activity as a Real Estate Professio-
                                                      tate choose to treat the trust as part of the es-           nal (as discussed later, under Activities
Special $25,000 allowance. If you or your             tate. The choice applies to tax years ending af-            That Aren’t Passive Activities).
spouse actively participated in a passive rental      ter the decedent's death and before:                    • Any overall loss from a publicly traded
real estate activity, the amount of the passive          • 2 years after the decedent's death if no es-           partnership (see Publicly Traded Partner-
activity loss that’s disallowed is decreased and            tate tax return is required, or                       ships (PTPs) in the instructions for Form
you therefore can deduct up to $25,000 of loss           • 6 months after the estate tax liability is fi-         8582).
from the activity from your nonpassive income.              nally determined if an estate tax return is       • The deduction allowed for the deductible
This special allowance is an exception to the               required.                                             part of self-employment tax.
general rule disallowing the passive activity                                                                 • The deduction for domestic production ac-
loss. Similarly, you can offset credits from the          The choice is irrevocable and can’t be made
                                                      later than the due date for the estate's first in-          tivities.
activity against the tax on up to $25,000 of non-                                                             • The deduction allowed for interest on stu-
passive income after taking into account any          come tax return (including any extensions).
                                                          Limited partners aren’t treated as actively             dent loans.
losses allowed under this exception.
                                                      participating in a partnership's rental real estate            At the time this Publication went to
    If you’re married, filing a separate return,
                                                      activities.                                                    print, the tuition and fees deduction
and lived apart from your spouse for the entire
                                                          You aren’t treated as actively participating in
                                                                                                               !
                                                                                                             CAUTION that would've been excluded in calcu-
tax year, your special allowance can’t be more
                                                      a rental real estate activity unless your interest    lating modified adjusted gross income had ex-
than $12,500. If you lived with your spouse at
                                                      in the activity (including your spouse's interest)    pired. To find out if legislation extended the de-
any time during the year and are filing a sepa-
                                                      was at least 10% (by value) of all interests in the   duction, go to IRS.gov/Pub925.
rate return, you can’t use the special allowance
                                                      activity throughout the year.


Page 4                                                                                                                                           Publication 925 (2018)
Example. During 2018, John was unmar-                                    1. Trade or business activities in which you               sive Activities, under Recharacterization of
ried and wasn’t a real estate professional. For                                 materially participated for the tax year.               Passive Income, later.
2018, he had $120,000 in salary and a $31,000
                                                                             2. A working interest in an oil or gas well             5. You materially participated in the activity
loss from his rental real estate activities in which
                                                                                which you hold directly or through an entity            (other than by meeting this fifth test) for
he actively participated. His modified adjusted
                                                                                that doesn’t limit your liability (such as a            any 5 (whether or not consecutive) of the
gross income is $120,000. When he files his
                                                                                general partner interest in a partnership). It          10 immediately preceding tax years.
2018 return, he can deduct only $15,000 of his
                                                                                doesn’t matter whether you materially par-
passive activity loss. He must carry over the re-                                                                                    6. The activity is a personal service activity in
                                                                                ticipated in the activity for the tax year.
maining $16,000 passive activity loss to 2019.                                                                                          which you materially participated for any 3
                                                                                However, if your liability was limited for
He figures his deduction and carryover as fol-                                                                                          (whether or not consecutive) preceding
                                                                                part of the year (for example, you conver-
lows.                                                                                                                                   tax years. An activity is a personal service
                                                                                ted your general partner interest to a limi-
                                                                                                                                        activity if it involves the performance of
                                                                                ted partner interest during the year) and
 Adjusted gross income, modified as                                                                                                     personal services in the fields of health (in-
                                                                                you had a net loss from the well for the
 required . . . . . . . . . . . . . . . . . . .   . . . . .     $120,000                                                                cluding veterinary services), law, engi-
                                                                                year, some of your income and deductions
                                                                                                                                        neering, architecture, accounting, actuarial
                                                                                from the working interest may be treated
 Minus amount not subject to phaseout                 . . . .   –100,000                                                                science, performing arts, consulting, or
                                                                                as passive activity gross income and pas-
                                                                                                                                        any other trade or business in which capi-
                                                                                sive activity deductions. See Temporary
 Amount subject to phaseout rule             . . . . . . . .     $20,000                                                                tal isn’t a material income-producing fac-
 Multiply by 50% . . . . . . . . . . .                            × 50%         Regulations section 1.469-1T(e)(4)(ii).
                                            . . . . . . . .                                                                             tor.
                                                                             3. The rental of a dwelling unit that you also
 Required reduction to special                                                                                                       7. Based on all the facts and circumstances,
                                                                                used for personal purposes during the
 allowance . . . . . . . . . . . . .                             $10,000                                                                you participated in the activity on a regu-
                                       . . . . . . . . . . .
                                                                                year for more than the greater of 14 days
                                                                                                                                        lar, continuous, and substantial basis dur-
                                                                                or 10% of the number of days during the
 Maximum special allowance             . . . . . . . . . . .     $25,000                                                                ing the year.
                                                                                year that the home was rented at a fair
 Minus required reduction (see above)                . . . .     –10,000        rental.                                                You didn’t materially participate in the activ-
                                                                             4. An activity of trading personal property for       ity under test (7) if you participated in the activ-
 Adjusted special allowance          . . . . . . . . . . . .     $15,000        the account of those who own interests in          ity for 100 hours or less during the year. Your
                                                                                the activity. See Temporary Regulations            participation in managing the activity doesn’t
 Passive loss from rental real estate             . . . . . .    $31,000        section 1.469-1T(e)(6).                            count in determining whether you materially
                                                                                                                                   participated under this test if:
 Deduction allowable/Adjusted                                                5. Rental real estate activities in which you            • Any person other than you received com-
 special allowance (see above)            . . . . . . . . .      –15,000        materially participated as a real estate pro-            pensation for managing the activity, or
                                                                                fessional. See Real Estate Professional,              • Any individual spent more hours during the
 Amount that must be carried forward                . . . . .    $16,000        later.                                                   tax year managing the activity than you did
                                                                                                                                         (regardless of whether the individual was
                                                                                   You shouldn’t enter income and losses
    Exceptions to the phaseout rules. A                                                                                                  compensated for the management serv-
                                                                              !    from these activities on Form 8582. In-
higher phaseout range applies to rehabilitation                                                                                          ices).
                                                                           CAUTION stead, enter them on the forms or
investment credits from rental real estate activi-
                                                                           schedules you would normally use.
ties. For those credits, the phaseout of the                                                                                       Participation. In general, any work you do in
$25,000 special allowance starts when your                                                                                         connection with an activity in which you own an
modified adjusted gross income exceeds                                     Material Participation                                  interest is treated as participation in the activity.
$200,000 ($100,000 if you’re a married individ-
ual filing a separate return and living apart at all                                                                                   Work not usually performed by owners.
                                                                           A trade or business activity isn’t a passive activ-     You don’t treat the work you do in connection
times during the year).                                                    ity if you materially participated in the activity.
    There is no phaseout of the $25,000 special                                                                                    with an activity as participation in the activity if
allowance for low-income housing credits or for                                                                                    both of the following are true.
                                                                           Material participation tests. You materially
the CRD.                                                                                                                            • The work isn’t work that’s customarily done
                                                                           participated in a trade or business activity for a
                                                                                                                                        by the owner of that type of activity.
                                                                           tax year if you satisfy any of the following tests.
    Ordering rules. If you have more than one                                                                                       • One of your main reasons for doing the
of the exceptions to the phaseout rules in the                               1. You participated in the activity for more               work is to avoid the disallowance of any
same tax year, you must apply the $25,000                                       than 500 hours.                                         loss or credit from the activity under the
phaseout against your passive activity losses                                                                                           passive activity rules.
                                                                             2. Your participation was substantially all the
and credits in the following order.
                                                                                participation in the activity of all individuals       Participation as an investor. You don’t
  1. The portion of passive activity losses not                                 for the tax year, including the participation      treat the work you do in your capacity as an in-
     attributable to the CRD.                                                   of individuals who didn’t own any interest         vestor in an activity as participation unless
                                                                                in the activity.                                   you’re directly involved in the day-to-day man-
  2. The portion of passive activity losses at-
     tributable to the CRD.                                                                                                        agement or operations of the activity. Work you
                                                                             3. You participated in the activity for more
                                                                                                                                   do as an investor includes:
                                                                                than 100 hours during the tax year, and
  3. The portion of passive activity credits at-
                                                                                you participated at least as much as any             • Studying and reviewing financial state-
     tributable to credits other than the rehabili-                                                                                     ments or reports on operations of the activ-
                                                                                other individual (including individuals who
     tation and low-income housing credits.                                                                                             ity,
                                                                                didn’t own any interest in the activity) for
  4. The portion of passive activity credits at-                                the year.                                            • Preparing or compiling summaries or anal-
     tributable to the rehabilitation credit.                                                                                           yses of the finances or operations of the
                                                                             4. The activity is a significant participation             activity for your own use, and
  5. The portion of passive activity credits at-                                activity, and you participated in all signifi-       • Monitoring the finances or operations of
     tributable to the low-income housing                                       cant participation activities for more than             the activity in a nonmanagerial capacity.
     credit.                                                                    500 hours. A significant participation activ-
                                                                                ity is any trade or business activity in           Spouse's participation. Your participation in
Activities That Aren’t                                                          which you participated for more than 100
                                                                                hours during the year and in which you
                                                                                                                                   an activity includes your spouse's participation.
                                                                                                                                   This applies even if your spouse didn’t own any
Passive Activities                                                              didn’t materially participate under any of         interest in the activity and you and your spouse
                                                                                the material participation tests, other than       don’t file a joint return for the year.
The following aren’t passive activities.                                        this test. See Significant Participation Pas-


Publication 925 (2018)                                                                                                                                                          Page 5
Proof of participation. You can use             activities from an earlier year when you didn’t           Exception. The self-charged interest rules
        any reasonable method to prove your             qualify, see Treatment of former passive activi-      don’t apply to your interest in a partnership or S
RECORDS participation in an activity for the year.      ties under Passive Activities, earlier.               corporation if the entity made an election under
You don’t have to keep contemporaneous daily                                                                  Regulations section 1.469-7(g) to avoid the ap-
time reports, logs, or similar documents if you         Qualifications. You qualified as a real estate        plication of these rules. For more details on the
can establish your participation in some other          professional for the year if you met both of the      self-charged interest rules, see Regulations
way. For example, you can show the services             following requirements.                               section 1.469-7.
you performed and the approximate number of               • More than half of the personal services you
hours spent by using an appointment book, cal-               performed in all trades or businesses dur-       Passive Activity Income
endar, or narrative summary.                                 ing the tax year were performed in real
                                                             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
limited partner, you generally aren’t treated as          • You performed more than 750 hours of              gain from disposition of an interest in a passive
                                                             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.
activity if you met test (1), (5), or (6) under Ma-                                                               Passive activity income doesn’t include the
terial participation tests, discussed earlier, for          Don’t count personal services you per-            following items.
the tax year.                                           formed as an employee in real property trades           • Income from an activity that isn’t a passive
    You aren’t treated as a limited partner, how-       or businesses unless you were a 5% owner of                activity. These activities are discussed un-
ever, if you also were a general partner in the         your employer. You were a 5% owner if you                  der Activities That Aren’t Passive Activi-
partnership at all times during the partnership's       owned (or are considered to have owned) more               ties, earlier.
tax year ending with or within your tax year (or,       than 5% of your employer's outstanding stock,           • Portfolio income. This includes interest,
if shorter, during that part of the partnership's       outstanding voting stock, or capital or profits in-        dividends, annuities, and royalties not de-
tax year in which you directly or indirectly            terest.                                                    rived in the ordinary course of a trade or
owned your limited partner interest).                       If you file a joint return, don’t count your           business. It includes gain or loss from the
                                                        spouse's personal services to determine                    disposition of property that produces these
Retired or disabled farmer and surviving                whether you met the preceding requirements.                types of income or that’s held for invest-
spouse of a farmer. If you’re a retired or disa-        However, you can count your spouse's partici-              ment. The exclusion for portfolio income
bled farmer, you’re treated as materially partici-      pation in an activity in determining if you materi-        doesn’t apply to self-charged interest trea-
pating in a farming activity if you materially par-     ally participated.                                         ted as passive activity income. For more
ticipated for 5 or more of the 8 years before                                                                      information on self-charged interest, see
your retirement or disability. Similarly, if you’re a      Real property trades or businesses. A                   Self-charged interest, earlier.
                                                        real property trade or business is a trade or
surviving spouse of a farmer, you’re treated as                                                                 • Personal service income. This includes
materially participating in a farming activity if the   business that does any of the following with real          salaries, wages, commissions, self-em-
real property used in the activity meets the es-        property.                                                  ployment income from trade or business
tate tax rules for special valuation of farm prop-        • Develops or redevelops it.                             activities in which you materially participa-
erty passed from a qualifying decedent, and               • Constructs or reconstructs it.                         ted, deferred compensation, taxable social
you actively manage the farm.                             • Acquires it.                                           security and other retirement benefits, and
                                                          • Converts it.                                           payments from partnerships to partners for
Corporations. A closely held corporation or a             • Rents or leases it.                                    personal services.
personal service corporation is treated as mate-          • Operates or manages it.                             • Income from positive section 481 adjust-
rially participating in an activity only if one or        • Brokers it.                                            ments allocated to activities other than
more shareholders holding more than 50% by                  Closely held corporations. A closely held              passive activities. (Section 481 adjust-
value of the outstanding stock of the corpora-          corporation can qualify as a real estate profes-           ments are adjustments that must be made
tion materially participate in the activity.            sional if more than 50% of the gross receipts for          due to changes in your accounting
     A closely held corporation can also satisfy        its tax year came from real property trades or             method.)
the material participation standard by meeting          businesses in which it materially participated.         • Income or gain from investments of work-
the first two requirements for the qualifying busi-                                                                ing capital.
ness exception from the at-risk limits. See Spe-                                                                • Income from an oil or gas property if you
cial exception for qualified corporations under         Passive Activity Income                                    treated any loss from a working interest in
Activities Covered by the At-Risk Rules, later.         and Deductions                                             the property for any tax year beginning af-
                                                                                                                   ter 1986 as a nonpassive loss, as dis-
Real Estate Professional                                In figuring your net income or loss from a pas-            cussed in item (2) under Activities That
                                                        sive activity, take into account only passive ac-          Aren’t Passive Activities, earlier. This also
Generally, rental activities are passive activities     tivity income and passive activity deductions.             applies to income from other oil and gas
even if you materially participated in them.                                                                       property, the basis of which is determined
However, if you qualified as a real estate pro-         Self-charged interest. Certain self-charged                wholly or partly by the basis of the property
fessional, rental real estate activities in which       interest income or deductions may be treated               in the preceding sentence.
you materially participated aren’t passive activi-      as passive activity gross income or passive ac-         • Any income from intangible property, such
ties. For this purpose, each interest you have in       tivity deductions if the loan proceeds are used            as a patent, copyright, or literary, musical,
a rental real estate activity is a separate activity,   in a passive activity.                                     or artistic composition, if your personal ef-
unless you choose to treat all interests in rental           Generally, self-charged interest income and           forts significantly contributed to the crea-
real estate activities as one activity. See the In-     deductions result from loans between you and a             tion of the property.
structions for Schedule E (Form 1040), Supple-          partnership or S corporation in which you had a         • Any other income that must be treated as
mental Income and Loss, for information about           direct or indirect ownership interest. This in-            nonpassive income. See Recharacteriza-
making this choice.                                     cludes both loans you made to the partnership              tion of Passive Income, later.
                                                        or S corporation and loans the partnership or S         • Overall gain from any interest in a publicly
    If you qualified as a real estate professional      corporation made to you.                                   traded partnership. See Publicly Traded
for 2018, report income or losses from rental                It also includes loans from one partnership           Partnerships (PTPs) in the Instructions for
real estate activities in which you materially par-     or S corporation to another partnership or S cor-          Form 8582.
ticipated as nonpassive income or losses, and           poration if each owner in the borrowing entity          • State, local, and foreign income tax re-
complete line 43 of Schedule E (Form 1040). If          has the same proportional ownership interest in            funds.
you also have an unallowed loss from these              the lending entity.                                     • Income from a covenant not to compete.

Page 6                                                                                                                                Publication 925 (2018)
• Reimbursement of a casualty or theft loss          under the rules described in the preceding dis-                sive Activity Income and Deductions, ear-
   included in gross income to recover all or         cussion.                                                       lier.
   part of a prior year loss deduction, if the                                                                   •   Losses from dispositions of property that
   loss deduction wasn’t a passive activity de-       Disposition of property converted to inven-                    produce portfolio income or property held
   duction.                                           tory. If you disposed of property that you had                 for investment.
 • Alaska Permanent Fund dividends.                   converted to inventory from its use in another             •   State, local, and foreign income taxes.
 • Cancellation of debt income, if at the time        activity (for example, you sold condominium                •   Miscellaneous itemized deductions that
   the debt is discharged the debt isn’t alloca-      units you previously held for use in a rental ac-              may be disallowed because of the
   ted to passive activities under the interest       tivity), a special rule may apply. Under this rule,            2%-of-adjusted-gross-income limit.
   expense allocation rules. See chapter 4 of         you disregard the property's use as inventory              •   Charitable contribution deductions.
   Pub. 535, Business Expenses, for informa-          and treat it as if it were still used in that other ac-    •   Net operating loss deductions.
   tion about the rules for allocating interest.      tivity at the time of disposition. This rule applies       •   Percentage depletion carryovers for oil and
                                                      only if you meet all of the following conditions.              gas wells.
Disposition of property interests. Gain on               • At the time of disposition, you held your in-         •   Capital loss carrybacks and carryovers.
the disposition of an interest in property gener-           terest in the property in a dealing activity         •   Items of deduction from a passive activity
ally is passive activity income if, at the time of          (an activity that involves holding the prop-             that are disallowed under the limits on de-
the disposition, the property was used in an ac-            erty or similar property mainly for sale to              ductions that apply before the passive ac-
tivity that was a passive activity in the year of           customers in the ordinary course of a trade              tivity rules. See Coordination with other
disposition. The gain generally isn’t passive ac-           or business).                                            limitations on deductions that apply before
tivity income if, at the time of disposition, the        • Your other activities included a nondealing               the passive activity rules, later.
property was used in an activity that wasn’t a              activity (an activity that doesn’t involve           •   Deductions and losses that would have
passive activity in the year of disposition. An ex-         holding similar property for sale to custom-             been allowed for tax years beginning be-
ception to this general rule may apply if you pre-          ers in the ordinary course of a trade or                 fore 1987 but for basis or at-risk limits.
viously used the property in a different activity.          business) in which you used the property             •   Net negative section 481 adjustments allo-
                                                            for more than 80% of the period you held it.             cated to activities other than passive activi-
    Exception for more than one use in the               • You didn’t acquire or hold your interest in               ties. (Section 481 adjustments are adjust-
preceding 12 months. If you used the prop-                  the property for the main purpose of selling             ments required due to changes in
erty in more than one activity during the                   it to customers in the ordinary course of a              accounting methods.)
12-month period before its disposition, you                 trade or business.                                   •   Casualty and theft losses, unless losses
must allocate the gain between the activities on
                                                                                                                     similar in cause and severity recur regu-
a basis that reasonably reflects the property's
                                                      Passive Activity Deductions                                    larly in the activity.
use during that period. Any gain allocated to a
                                                                                                                 •   The deduction allowed for the deductible
passive activity is passive activity income.
                                                      Generally, a deduction is a passive activity de-               part of self-employment tax.
    For this purpose, an allocation of the gain
solely to the activity in which the property was      duction for a taxable year if and only if such de-
                                                      duction either:                                           Coordination with other limitations on de-
mainly used during that period reasonably re-                                                                   ductions that apply before the passive ac-
flects the property's use if the fair market value      1. Arises in connection with the conduct of             tivity rules. An item of deduction from a pas-
of your interest in the property isn’t more than           an activity that’s a passive activity for the        sive activity that’s disallowed for a tax year
the lesser of:                                             tax year; or                                         under the basis or at-risk limitations isn’t a pas-
  • $10,000, or                                                                                                 sive activity deduction for the tax year. The fol-
  • 10% of the total of the fair market value of        2. Is treated as a deduction from an activity
                                                           for the tax year because it was disallowed           lowing sections provide rules for figuring the ex-
      your interest in the property and the fair                                                                tent to which items of deduction from a passive
      market value of all other property used in           by the passive activity rules in the preced-
                                                           ing year and carried forward to the tax              activity are disallowed for a tax year under the
      that activity immediately before the dispo-                                                               basis or at-risk limitations.
      sition.                                              year.
                                                                                                                    Proration of deductions disallowed un-
    Exception for substantially appreciated               For purposes of item (1), above, an item of           der basis limitations. If any amount of your
property. The gain is passive activity income if      deduction arises in the taxable year in which the         distributive share of a partnership's loss for the
the fair market value of the property at disposi-     item would be allowable as a deduction under              tax year is disallowed under the basis limitation,
tion was more than 120% of its adjusted basis         the taxpayer's method of accounting if taxable            a ratable portion of your distributive share of
and either of the following conditions applies.       income for all taxable years were determined              each item of deduction or loss of the partner-
  • You used the property in a passive activity       without regard to the passive activity rules and          ship is disallowed for the tax year. For this pur-
     for 20% of the time you held your interest       without regard to the basis, excess farm loss,            pose, the ratable portion of an item of deduction
     in the property.                                 and at-risk limits. See Coordination with other           or loss is the amount of such item multiplied by
  • You used the property in a passive activity       limitations on deductions that apply before the           the fraction obtained by dividing:
     for the entire 24-month period before its        passive activity rules, later.
     disposition.                                                                                                 1. The amount of your distributive share of
                                                                                                                     partnership loss that’s disallowed for the
If neither condition applies, the gain isn’t pas-        Passive activity deductions generally in-                   taxable year; by
sive activity income. However, it’s treated as        clude any loss from a disposition of property
portfolio income only if you held the property for    used in a passive activity at the time of the dis-          2. The sum of your distributive shares of all
investment for more than half of the time you         position and any loss from a disposition of less               items of deduction and loss of the partner-
held it in nonpassive activities.                     than your entire interest in a passive activity.               ship for the tax year.
    For this purpose, treat property you held
through a corporation (other than an S corpora-                                                                     If any amount of your pro rata share of an S
                                                      Exceptions. Passive activity deductions don’t
tion) or other entity whose owners receive only                                                                 corporation's loss for the tax year is disallowed
                                                      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
ment. Also, treat the date you agree to transfer                                                                loss of the S corporation is disallowed for the
                                                           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
    If you used the property in more than one                                                                   such item multiplied by the fraction obtained by
                                                           expenses (other than self-charged inter-
activity during the 12-month period before its                                                                  dividing:
                                                           est) properly allocable to passive activities.
disposition, this exception applies only to the            For more information on self-charged inter-            1. The amount of your share of S corporation
part of the gain allocated to a passive activity           est, see Self-charged interest under Pas-                 loss that’s disallowed for the tax year; by


Publication 925 (2018)                                                                                                                                     Page 7
2. The sum of your pro rata shares of all            Grouping Your Activities                                   • Four separate activities.
     items of deduction and loss of the corpora-
     tion for the tax year.                            You can treat one or more trade or business ac-                Example 2. Betty is a partner in ABC part-
                                                       tivities, or rental activities, as a single activity if   nership, which sells nonfood items to grocery
    Proration of deductions disallowed un-                                                                       stores. Betty is also a partner in DEF (a trucking
                                                       those activities form an appropriate economic
der at-risk limitation. If any amount of your                                                                    business). ABC and DEF are under common
                                                       unit for measuring gain or loss under the pas-
loss from an activity (as defined in Activities                                                                  control. The main part of DEF's business is
                                                       sive activity rules.
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 ac-       tivity 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         you add or dispose of any activities in your
     Coordination of basis and at-risk limita-
                                                       activity.                                                 groupings.
tions. The portion of any item of deduction or
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
and loss. In identifying the items of deduction        Generally, to determine if activities form an ap-
                                                                                                                 Regrouping by the IRS. If any of the activities
and loss from an activity that aren’t disallowed       propriate economic unit, you must consider all
                                                                                                                 resulting from your grouping isn’t an appropriate
under the basis and at-risk limitations (and that      the relevant facts and circumstances. You can
                                                                                                                 economic unit and one of the primary purposes
therefore may be treated as passive activity de-       use any reasonable method of applying the rel-
                                                                                                                 of your grouping (or failure to regroup) is to
ductions), you needn’t account separately for          evant facts and circumstances in grouping ac-
                                                                                                                 avoid the passive activity rules, the IRS may re-
any item of deduction or loss unless such item         tivities. The following factors have the greatest
                                                                                                                 group your activities.
may, if separately taken into account, result in       weight in determining whether activities form an
an income tax liability different from that which      appropriate economic unit. All of the factors
                                                                                                                 Rental activities. In general, you can’t group a
would result were such item of deduction or            don’t have to apply to treat more than one activ-
                                                                                                                 rental activity with a trade or business activity.
loss taken into account separately.                    ity as a single activity. The factors that you
                                                                                                                 However, you can group them together if the
   Items of deduction or loss that must be ac-         should consider are:
                                                                                                                 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 rela-
  1. Are attributable to separate activities. See                                                                     tion to the trade or business activity,
                                                         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
                                                         4. The geographical location, and
                                                                                                                   • Each owner of the trade or business activ-
     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
     ticipate in such activity.                                                                                       business activity may be grouped with the
                                                              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 corpo-
                                                                                                                 ration, 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 busi-
                                                                                                                 ness 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 ac-
                                                             tivity, or

Page 8                                                                                                                                   Publication 925 (2018)
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