As a limited partner in Joey Badofdonuts LLP, your ability to deduct partnership losses may be limited due to the passive activity loss rules.
A passive activity is any activity which involves the conduct of any trade or business, and in which you do not materially participate.
Generally, you are treated as materially participating in an activity only if you are involved in the operations of the activity on a basis which is regular, continuous, and substantial.
You are treated as materially participating in an activity for the tax year if and only if you meet one of the following criteria:
(1) you participate in the activity for more than 500 hours during the year;
(2) your participation in the activity for the tax year constitutes substantially all of the participation in such activity of all individuals (including individuals who are not owners of interests in the activity) for the year;
(3) you participate in the activity for more than 100 hours during the tax year, and your participation in the activity for the tax year is not less than the participation in the activity of any other individual (including individuals who are not owners of interests in the activity) for such year;
(4) the activity is a significant participation activity for the tax year, and your aggregate participation in all significant participation activities during the year exceeds 500 hours;
(5) you materially participated in the activity for any five tax years (whether or not consecutive) during the ten tax years that immediately precede the tax year;
(6) the activity is a personal service activity, and you materially participated in the activity for any three tax years (whether or not consecutive) preceding the tax year; or
(7) based on all of the facts and circumstances, you participate in the activity on a regular, continuous, and substantial basis during the year.
The material participation tests generally do not apply to rentals, except for the rental real estate of a real estate professional.
However, the IRS treats an interest in a limited partnership as presumptively passive. Thus, as a limited partner, you are generally treated as not materially participating in the partnership and your losses are only deductible against passive activity income.
Under the IRS rules, this treatment can be negated only if the limited partner worked more than 500 hours for the year in the activity, materially participated for five of the last ten years, or materially participated in a personal service activity for any three prior years.
There is some controversy between the courts and the IRS relating to what constitutes a limited partner interest in a limited partnership for purposes of determining whether a taxpayer materially participates in an activity.
The IRS has issued rules under which an interest in an entity will be treated as an interest in a limited partnership (and thus presumptively passive) if:
(1) the entity in which such interest is held is classified as a partnership for federal income tax purposes, and
(2) the holder of such interest does not have rights to manage the entity at all times during the entity’s tax year under the law of the jurisdiction in which the entity was organized and under the governing agreement. Rights to manage include the power to bind the entity.
If you have any questions regarding your ability to take advantage of losses generated by Joey Badofdonuts LLP, please give me a call.
Please contact the office of Don Fitch Accountancy at (760)567-3110 or Email Don.Fitch@CPA.com if you have any questions or would like additional information.
DON FITCH, CPA
74478 Highway 111 #3
Palm Desert, CA 92260
Toll Free: (877)CPA-Help or (877)272-4357
P.S. My firm is based upon referrals. Please feel free to refer my firm to anyone you know that is looking for a new CPA and/or tax preparer. Thank you in advance.
(Updated 07052021-01 320-630)