Passive activity grouping disclosure statements.

• Author: Miller, John L.

The passive activity loss and credit limitation rules in Sec. 469 apply to individuals, trusts, estates, personal service corporations, and closely held C corporations. The rules prevent taxpayers subject to them from applying losses or credits generated by rental activities and activities in which they do not materially participate against investment income, compensation, or income from activities in which they do materially participate. In order to be treated as materially participating in an activity, a taxpayer must be involved in the operations of the activity on a regular, continuous, and substantial basis.

Taxpayers who are involved in multiple separate but related trade or business activities may find it difficult to meet the stringent material participation requirements of Sec. 469 for each activity. In addition, activities that involve property rental are treated as passive activities regardless of whether the taxpayer materially participates. As a result, the application of the passive activity rules could produce harsh results were it not for provisions in Regs. Sec. 1.469-4(c)(l) that allow taxpayers to treat separate activities as a single activity for the purposes of Sec. 469. Generally, a taxpayer may treat multiple trade, business, or rental activities as a single activity if the facts and circumstances indicate that they constitute an appropriate economic unit.

The rules in Regs. Sec. 1.469-4 place limits on which activities may be aggregated and limit the ability of taxpayers to change groupings from year to year. Once a taxpayer has grouped activities for a tax year, changes to groupings are generally not allowed. Changes are required, however, when it is determined that the taxpayer's original grouping was clearly inappropriate or becomes inappropriate as a result of a material change in the facts and circumstances.

Grouping Disclosure Statements

Except for a special provision in Regs. Sec 1.469-9(g) that applies only to certain real estate professionals, taxpayers have not been required to file grouping election forms or disclosure statements. As a result, it is difficult for the IRS to determine whether groupings are appropriate or whether prohibited changes have been made to groupings.

In 2008, the IRS issued Notice 2008-64, in which it proposed rules to require the filing of written statements with tax returns to disclose the grouping of activities under the passive activity regulations. After considering comments...