Interests in LLCs and LLPs not presumed to be passive activities.

• Author: Beavers, James
• Position: Limited liability companies, limited liability partnerships

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Interests in LLCs and LLPs Not Presumed to Be Passive Activities

The Tax Court held that the taxpayers' interests in their LLPs and LLCs were not presumptively passive because they did not hold their interests in the entities as limited partners in a limited partnership.

Background

Paul and Alicia Garnett owned interests in seven limited liability partnerships (LLPs) and two limited liability companies (LLCs) that were engaged in agribusiness operations, primarily the production of poultry, eggs, and hogs. For the years 2000-2002, the Garnetts reported income and losses from these LLPs and LLCs on their income tax returns as income and losses from activities in which they materially participated. The IRS disallowed some of these losses from each year, asserting that the losses were passive activity losses because the taxpayers had failed to meet the material participation requirements of Sec. 469.

In determining that the losses were passive losses, the IRS took the position that the Garnetts' interests in the LLPs and LLCs were limited partnership interests that were subject to Sec. 469(h)(2), which treats a limited partner's losses from an interest in a limited partnership as presumptively passive. The Garnetts challenged the IRS's determination in Tax Court and asked for a ruling that Sec. 469(h)(2) was not applicable to their interests in the LLPs or LLCs because the entities were not limited partnerships and they held their interests in the entities as general partners.

Sec. 469(h)(2)

Sec. 469(h)(2) states: "Except as provided in regulations, no interest in a limited partnership as a limited partner shall be treated as an interest with respect to which a taxpayer materially participates." The currently applicable temporary regulations under Sec. 469(h) (2) permit a taxpayer to establish material participation in a limited partnership but allow the taxpayer to use only three of the seven regulatory tests. Temp. Regs. Sec. 1.469-5T(e) provides:

(e) Treatment of limited partners--(1) General rule.--Except as otherwise provided in this paragraph (e), an individual shall not be treated as materially participating in any activity of a limited partnership for purposes of applying section 469 and the regulations thereunder to--

(i) The individual's share of any income, gain, loss, deduction, or credit from such activity that is attributable to a limited partnership interest in the partnership; and

(ii) Any gain or loss...