Electing Passive Treatment

[Snaggletooth]

I have thought that passive activities was not something you could "elect". The activities were either "passive" by definition, or they weren't.

However, I've run into two situations - I've posted recently about one of them. Can a taxpayer designate (or at least CLAIM) them to be passive?

1. Taxpayer own a proprietorship in a foreign country. He spends no time managing the company, and functions as an investor only. However as a proprietor he files a schedule C. We have been forcing passive treatment by filing an "at risk" form 6198. He is not really "at risk" but this allows the software to not deduct losses.

2. Two "partners" have invested in land. There is no activity on the land and it is held for investment purposes only. (If this were a corporation, I think it would be a Personal Holding Company 1120-PH) They have been filing a 1065 partnership every year, and with no revenue, have been claiming taxes, insurance, and mowing expenses as an "ordinary loss." The Schedule K allows the loss to be deducted, but there is always the designation of a passive activity on the back that the preparer can check to disallow the loss.

Comments??

[appelman]

Items 1 and 2

Item 1: Should he really be filing a Schedule C? If he does, it's hard to see how losses can be passive. I don't think "passivity" is an elective.

Item 2: Pass through as Schedule A deductions. Taxes are always deductible, and the rest would be investment expense. At least that would be my take.

A somewhat related question about which I've often wondered: Is the special rental allowance for passive loss elective? The pubs tend to use the word "may."

[Gretel]

I would question the necessity to file Schedule C for item no. 1 also.

For item no. two I also see no problems claiming the taxes, but am thinking (aloud) that all other expenses need to be capitalized?

[Roland Slugg]

I have thought that passive activities was not something you could "elect". The activities were either "passive" by definition, or they weren't.

You're right. The passive/nonpassive nature of an activity is a factual one, not an elective one.

For that Schedule C business, check the box "No" that asks if the taxpayer materially participates. Your software should then classify it as passive. You are incorrect to check the "At-risk" box if the T/P is, in fact, fully at risk financially.

To those who say Schedule C should not be filed I ask where on the return would you report the income and expenses of this business?

Regarding the land "partnership," it isn't really a partnership ... at least not in a tax sense ... it is mere common ownership of property. The IRS makes it clear that when there is no business being operated, a partnership return should not be filed. Why go to all the trouble and expense? As others have pointed out each owner can still deduct his share of real estate taxes, or any co-owner who does not itemize can instead make an election to capitalize his share if the taxes under Code §266 and related Regs §1.266-1. The mowing cost may be one that can also be capitalized.

[Gary2]

In addition to Roland's reply, with which I agree, Passive Activity Losses call for Form 8582. It doesn't sound like 6198 is needed in your case, though sometimes both are required.

[appelman]

Good point on the Schedule C

I guess that IS where it has to go I had forgotten that a "no" to material participation will suffice to make any losses passive.

It is not clear to me that costs to maintain investment property necessarily need to be capitalized.

[DMICPA]

Elections

I believe an election can be made under IRC 1.266-1 to capitalize carrying charges on raw land.

These charges would add to basis.

I understand the Schedule C comments, but I have clients that invest in Oil-Gas partnerships or Schedule C entities and the forms they receive classify the activities as active. These clients don't even know where the gas-oil properties are yet they have been classified as active. I have only seen this in oil-gas operations.

[Gary2]

I understand the Schedule C comments, but I have clients that invest in Oil-Gas partnerships or Schedule C entities and the forms they receive classify the activities as active. These clients don't even know where the gas-oil properties are yet they have been classified as active. I have only seen this in oil-gas operations.

That's an explicit exception in the code, section 469(c)(3).

[Jesse]

Regarding the land "partnership," it isn't really a partnership ... at least not in a tax sense ... it is mere common ownership of property. The IRS makes it clear that when there is no business being operated, a partnership return should not be filed. Why go to all the trouble and expense? As others have pointed out each owner can still deduct his share of real estate taxes, or any co-owner who does not itemize can instead make an election to capitalize his share if the taxes under Code §266 and related Regs §1.266-1. The mowing cost may be one that can also be capitalized.

Would it make a difference if it is two individuals or if it is two individuals that formed a LLC? I have a similar situation and each year we file a Form 1065 to make the election to capitalize the property taxes and interest on the land. That is all they have and I would love not to file the 1065 if I can just do it on the personal tax return.

Can the expense for mowing be capitalized?

[Snaggletooth]

Section §266

or any co-owner who does not itemize can instead make an election to capitalize his share if the taxes under Code §266 and related Regs §1.266-1.

In the case of electing §266, he is capitalizing his basis in the PARTNERSHIP and not the partnership basis in the land, right? So the only way he gets the benefit of this is if if the partnership dissolves or he sells his share of the partnership. The partnership sells the property for a gain, then only its original cost becomes calculation for the gain. The owner who has elected §266 gets a K-1 for the full gain and cannot use his §266 election to reduce his gain.

Is this correct??