Rev. Proc. 2002-22: co-ownership of property or partnership interest?

AuthorMerrill, Geena

On March 19, 2002, the IRS released Rev. Proc. 2002-22, establishing the conditions under which a taxpayer may request a letter ruling that an undivided fractional interest in rental real property is not an interest in a business entity within the meaning of Regs. Sec. 301.7701-2(a) (i.e., that the co-ownership of property is not a corporation or a partnership for Federal tax purposes).

In general, the determination of whether an organization creates an entity separate from its owners for Federal tax purposes is a matter of Federal tax law, not dependent on whether the arrangement is recognized as an entity under local law (Regs. Sec. 301.7701-1(a)(1)). A joint venture or other contractual arrangement may create a separate entity for Federal tax purposes if the participants carry on a trade, business, financial operation or venture, and divide the profits therefrom. However, mere co-ownership of property that is maintained, kept in repair and rented or leased generally does not constitute a separate entity for Federal tax purposes (Regs. Sec. 301.7701-1(a)(2)).

Taxpayers that co-own real property often lease the property and share in the rents, as well as the costs and expenses of maintaining the property. For each co-ownership of income-producing property, taxpayers must determine whether the arrangement is merely property co-ownership or whether the taxpayers' joint activities rise to the level of a separate entity. The line, however, is not always clear.

In Rev. Rul. 75-374, the IRS concluded that co-ownership of an apartment building in which the co-owners' agent provided customary services (such as heat, air conditioning, trash removal and maintenance of common areas) to the tenants was not sufficient joint activity for partnership status. Conversely, the Tax Court determined that a partnership existed when the economic benefits enjoyed by the co-owners resulted not from co-ownership of the property, but from the pursuit of a common goal; see Bergford, 12 F3d 166 (9th Cir. 1993); Bussing, 88 TC 449, aff'd on reh'g, 89 TC 1050 (1987); and Alhouse, TC Memo 1991-652, aff'd sub. nom. Bergford, 12 F3d 166. Specifically, the Tax Court concluded that a partnership exists when (1) the co-owners or their agent performs services that are more than customary (such as arranging financing, collecting rents, preparing statements and purchasing and leasing equipment), (2) the co-owners' ability to sell, lease or encumber either their undivided...

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