How would you handle?

[oceanlovin'ea]

I have a long time client who has 2 LLC's at the present time. They both have a rental property in them.One is partnership with husband and wife as the 2 partners. The other is husband as one partner and another person as the second partner.

I wrote a very lengthy email to client explaining the difference between active participation and material participation to them. This is a confusing issue to me. I had filed as material participation in previous years. They also have an AGI over $150,000.

They have a management company that collects rent and does repairs as needed but they are consulted by management company and make all decisions and authorize the repairs or work as it needs to be done. They go to the properties several times a year. I didn't really know if they spent 100 hours a year or not.

She wrote back saying she understands the difference and feels they qualify for material participation and wants to file that way. Since they have always filed that way, she feels secure in her position.

What would you do? Would you file it as material participation, which would allow their losses?

Thanks Linda F

[les grans]

Linda: Please check the passive activity/rental property/real estate professional rules carefully; I think that your client has to be working in real estate to a really big degree [that's not a technical term...], in addition to "materially participating" in their rental properties, to get to the result you got to, which is called "real estate professional" or "taxpayers in real property business" in IRC section 469(c)(7).
Is your client a "real estate professional"?

[oceanlovin'ea]

Wachovia Bank

They both work for Wachovia bank in the financial departments.

Linda F

[David1980]

They both work for Wachovia bank in the financial departments.

Linda F

Does that make them a "real estate professional"? I'd think they would need more than to simply be employees of a bank in order to get status as real estate professional. Doesn't the financial department in a bank deal with a lot of stuff that is not real estate?

And perhaps relevant quote from IRS 8582 instructions:
"Services you performed as an employee are not treated as performed in a real property trade or business unless you owned more than 5% of the stock (or more than 5% of the capital or profits interest) in the employer."

[oceanlovin'ea]

No

les grans asked if they were real estate professionals. I was just stating that they work at Wachovia Bank. I wouldn't class them as real estate professionals. I think they are more in the investment business.
The rental property is investment property for them.

Linda F

[oceanlovin'ea]

Found checklist

I found a checklist for determining material participation in material I have from a NCPE Individual Income Tax Workshop I attended a few years ago. It says, "The following checklist provides a guide for determining material participation. A yes answer to any of the questions below indicates that the taxpayer meets the material participation test with respoect to the particular activity."
There is also a checklist determining material participation under Facts-And-Circumstances Test.

This was very helpful to me. Anyone wants a copy can email me and I will fax it to them.

Linda F

[David1980]

Material participation probably doesn't matter

I think that your client has to be working in real estate to a really big degree [that's not a technical term...], in addition to "materially participating" in their rental properties, to get to the result you got to

Well, the thing is, it might not even matter if they are materially participating, as les grans pointed out there.

Material participation does not make a real estate rental non-passive income. See form 8582 instructions page 2:

"A rental activity is a passive activity even if you materially participated in the activity (unless it is a rental real estate activity in which you materially participated and you were a real estate professional)."

So you would still be subject to passive loss limitations (and if taxpayer has over $150k MAGI they get no loss.)