passive activity losses

Tax Court Allows Passive Activity Losses from a Distance

May 28th 2019
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The tax law limits the benefits derived from certain “passive activities” where a taxpayer fails to “materially participate” in the activity. Typically, this limit may apply to absentee landlords and business owners who sit on the sidelines. However, in a new case, Barbara, TC Memo 2019-50, 5/13/19, the Tax Court said that a business owner who mostly worked remotely from another location qualified as a material participant.

Generally, losses from passive activities can only offset income earned from other passive activities. Any excess passive loss is suspended unless you can satisfy one of seven tests spelled out in the IRS regulations. For example, you’re treated as a material participant if you work more than 500 hours a year on the activity. Another requirement is met if you (1) participate more than 100 hours in the activity during the year and (2) the facts and circumstances indicate that your participation was regular, continuous and substantial.

Here's the facts of the new case: The taxpayer was in the business of lending money from an office in Chicago. The office was staffed full-time by an accountant and a secretary.

Normally, the taxpayer performed all the executive functions for the lending business. He decided when to make loans and how to handle defaulted ones. He managed over 40 outstanding loans during 2009 through 2012, the four tax years in question

During this period, the taxpayer split his time between Chicago and Florida. For each year, he was in Chicago 40 percent of the time, and the other 60 percent was spent in Florida. He worked at least 200 days in a year.

When he was in in Chicago, the taxpayer regularly went to the office for about 5-3/4 hours each workday. Conversely, when the taxpayer was in Florida, he lived in a house that he owned. He called the Chicago office every day when it opened at 9 am and communicated at other times by telephone, fax and e-mail. He averaged at least two hours of work per day on the lending business while residing in Florida.

The business reported losses for three of the years at issue. The IRS contended that these constituted passive activity losses and the taxpayer was not a material participant.

This is a taxpayer victory: The Tax Court did the math and sided with him. It said that the amount of time shown spent on regular, continuous and substantial participation satisfied the IRS regulations.

In this day and age, many of your clients may work remotely or have other business arrangements and rely on technology to do their jobs from far away. You don’t have to always be in the office anymore to meet one of the material participation tests. Advise your clients about the latest developments. 

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