Passive Income-

[KC-CPA]

I have new business client who builds residential houses. Its a partnership with two partners, ownership 50/50. In reviewing previous years returns done by another accountant the income of the partnership, roughly $50 from box 1 of K-1 he recorded as passive income on schedule E 28(g). Both partners work the business everyday and are actively involved in daily decisions. I believe this should be recorded as non-passive. Since it is income there is no impact on the overall income tax. Am I missing something about builders and passive income?

[Roland Slugg]

The classification of an activity as passive or nonpassive is not based on how often its owner/investor works at it, but how much time is devoted. A business activity that might seem like a nonpassive one could very well be correctly classified as passive for any particular owner if he doesn't meet the "material participation" requirement as defined in Code §469(h) and related Regs. To determine for your client the proper classification of the activity in question, you must review those requirements to see if he meets any of them.

[KC-CPA]

Thank You. I agree. This is his full time business, he works it 100% of the time, he definitely participates materially, about 50 - 70 hours per week.

[FEDUKE404]

Homebuilding is a passive activity ? ?

It would seem to me quite a stretch to rationalize that someone "who builds residential houses" could even be considered to be participating in a passive activity.

That's a new one on me!

FE

[Roland Slugg]

It would seem to me quite a stretch to rationalize that someone "who builds residential houses" could even be considered to be participating in a passive activity.

Rationalize? How on Earth do you equate applying the "material participation" rules in classifying an activity as passive or nonpassive as "rationalizing?"

I have a client who is a veterinarian and owns a veterinary hospital. It's an unincorporated business and is reported on a Schedule C in his personal return. Is that veterinary hospital a passive or a nonpassive activity for him?

I have another client who owns a successful restaurant. It's also an unincorporated business and is reported on a Schedule C in her personal return. Is that restaurant a passive or a nonpassive activity for her?

I have yet another client who owns a cement ready-mix business. Is that ready-mix business a passive or a nonpassive activity for him?

All nonpassive you say?

Actually, they are all passive activities.

It's impossible to decide if an activity is passive or nonpassive by simply looking at the type of business or nature of the activity. That classification depends, in some cases, on the amount of participation in the activity by the taxpayer in question, and those participation rules are clearly spelled out in the Code and Regs.

The veterinarian referred to above is employed full-time (4 days a week) at another large veterinary hospital in which he has no ownership interest. He works at his own veterinary hospital every other Friday ... about 200 hours per year ... to relieve the regular veterinarian who works there F/T and runs the hospital's day-to-day business.

The woman who owns the restaurant works F/T at a radio station as an on-air personality M-F afternoons. She meets with the restaurant's manager and executive chef two or three mornings per week for an hour or two, and drops by the restaurant after work two or three times a week to make visual observations and mingle with the customers. Total time participating in the restaurant's business, maybe 300~350 hours per year.

The owner of the ready-mix business drops by around 7:00a almost every morning to get the pulse of the business, pay bills, talk with the dispatcher and the foreman, and so on. He's usually gone by 8:30a and on the golf course by 9:00a. Annual time devoted is about 400 hours. Actually the ready-mix business is incorporated, so the passive activity rules don't even apply, but I've included it here to further make the underlying point. If this business wasn't incorporated, it would be a passive activity for its owner.

And that point is that as tax preparers, and in some cases tax advisers, as well, we shouldn't make assumptions or jump to conclusions based on guesswork or emotional views. If we aren't absolutely sure of something, there is no alternative to looking it up. In most cases it's not very hard to do.

[FEDUKE404]

Uncle !!

Rightly or wrongly, I misread the original post as the taxpayer being one of three persons actively engaged in a home construction business (layman's read: HE BUILDS HOUSES!!), to include "Both partners work the business everyday and are actively involved in daily decisions."

Heck, maybe the client actively runs a full-time tax preparation business instead and just likes to window-shop at Home Depot on a regular basis.

Memo to self: Why do I even continue to torture myself with tax work in the first place?? I don't need this sh......erbert!

FE

[Snaggletooth]

Stretching the imagination

It is highly unlikely but the partnership may have invested in a security which has limited liability. That could make the $50 on K-1 correct. Otherwise both of the foregoing members are correct in that if both partners are actively engaged, a "not at risk" classification is improper.