Revenue procedure adds new disclosure requirements for grouping of passive activities.

• Author: Patch, David

Sec. 469 generally provides that losses from passive trade or business activities are disallowed and carried forward to the extent they exceed income from all such passive activities during the tax year. Similar limitations apply to credits generated by passive activities.

Regs. Sec. 1.469-4 sets forth rules for grouping a taxpayer's trade or business activities and rental activities for purposes of applying the passive activity loss and credit limitations. In general, those regulations provide that one or more trade or business or rental activities may be treated as a single activity if the activities constitute an "appropriate economic unit" for the measurement of gain or loss for purposes of Sec. 469.

Taxpayers are generally allowed to use any reasonable method in determining the appropriate grouping of their activities based on all the relevant facts and circumstances. However, the regulations impose specific limits on the grouping of rental with nonrental activities, real property rental activities with personal property rental activities, and activities engaged in as a limited partner or limited entrepreneur with any other activity. Factors a taxpayer must consider in determining whether two or more activities represent an appropriate economic unit include similarities and differences in types of trades or businesses; the extent of common control; the extent of common ownership; geographical location; and interdependencies between or among the activities.

Grouping is relevant for a number of reasons, and it is not always readily apparent what groupings will be most favorable to the taxpayer. For example, if a taxpayer engages in two activities and treats them as separate, he or she must establish material participation in each activity separately to avoid passive loss limitations. If instead the taxpayer groups the two activities into one larger activity, the taxpayer may combine his or her participation in both activities to establish material participation. Thus, if nonpassive treatment is preferable, it may be advantageous for the taxpayer to group the activities.

On the other hand, grouping activities may limit a taxpayer's ability to claim suspended losses upon disposition. Sec. 469(g) generally permits a taxpayer to claim suspended passive losses against nonpassive income when the taxpayer disposes of his or her entire interest in the activity in a fully taxable transaction. If the taxpayer groups two activities and later...