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Seven Tests to Qualifying Yourself as a Non-Passive Owner

January 05, 2015

Are You Considering an Investment in a Privately Held Company?

If you are a passive investor in a pass-through entity and don’t meet the material participation rules, losses generated from these investments may be suspended by the passive loss rules until there is sufficient income to offset those losses, or until the investment is sold. So how do you upgrade your status from passive investor to materially participating?

The material participation rules under Reg. § 1.469-5T(a) consist of 7 different tests. If you meet one of the tests, your losses will generally be deductible assuming no other limitations apply.

The 7 tests are listed below:

  1. You participate in the activity for more than 500 hours during the year.
  2. Your participation in the activity for the year constitutes substantially all of the participation in the activity of all individuals, including non-owners.
  3. You participate in the activity for more than 100 hours during the year, and your participation level during the year is not less than the participation level of any other individual, including non-owners.
  4. You participate in the activity for more than 100 hours during the 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 consecutive or non-consecutive taxable years during the ten taxable years that immediately precede the current year.
  6. The activity is a personal service activity and you materially participated in the activity for any three taxable years preceding the current year (consecutive or non-consecutive).
  7. Based on the facts and circumstances, you participate in the activity on a regular, continuous, and substantial basis during the year.

Keep in mind that these rules are complex and other rules and exclusions may apply depending on your particular situation. There are also additional rules for rental real estate income and losses. If you are considering an investment in a pass-through entity, please contact us. We can help you sort through the complexities and determine the strategy that’s right for you.

Read our recent blog “Do You Have Investments Subject to the Passive Activity Rules?” to learn more.

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