Nonpassive losses: new case treats losses from LLPs, LLCs as nonpassive.

• Author: Josephs, Stuart R.
• Position: Fed Tax

In Garnett v. Commissioner, 132 TC No. 19, June 30, 2009, the Tax Court held that the taxpayers did not own their interest in LLPs and LLCs as limited partners. Therefore, the losses from these interest were not presumptively passive under IRC Sec. 469(h)(2).

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Facts

For 2000-02, Paul and Alicia Garnett owned interests in seven LLPs and two LLCs that conducted agribusiness operations--primarily the production of poultry, eggs and hogs. The couple also owned interests in two other businesses that they characterized as tenancies in common. They owned most of those interests indirectly through five separate LLCs.

The IRS determined tax deficiencies of $361,468 and $72,294 or accuracy-related penalties for these tax years. The deficiencies arose primarily from the IRS' disallowance of losses from these interests claimed by the Garnetts. The IRS disallowed these losses under Sec. 469(a) as passive activity losses on the ground that the couple did not materially participate in the business entities' activities.

Statutory Provision

Sec. 469(h)(2) reads: "interests in Limited Partnerships--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." Observation. Thus, under this provision, losses from an interest in a limited partnership as a limited partner are treated as presumptively passive.

Legislative History

The 1986 Senate Finance Committee Report (No. 99-313 at 731-732, 1986-3 CB Vol.3) pertinently states the following:

"Under the bill, the Secretary of the Treasury is empowered to provide through regulations that limited partnership interests in certain circumstances will not be treated (other than through the application of the general facts and circumstances test regarding material participation) as interests in passive activities ... "The exercise of such authority might also be appropriate where taxpayers sought to avoid limited partnership status with respect to substantially equivalent entities."' (Emphasis added.)

The Conference Committee Report did not change this language.

Pertinent Regulation

Regs. Sec. 1.469-5T(eX3)(i) relevantly provides the following: "In general ... for purposes of section 469(h)(2) and this paragraph (e), a partnership interest shall be treated as a limited partnership interest if:

"(A) Such interest is designated a limited partnership interest in the limited...