Typically, a passive activity constitutes a business or rental activity whereby the tax-payer is not participating. On the other hand, a non-passive activity entails commercial activities whereby the tax-payer is engaged on a substantial basis, continuously and regularly. According to the Real Estate Tax, a passive income is exclusive of a portfolio, investment income or salaries. Generally, the passive activity losses, such as the one the Riccis have incurred are applied at a personal level. However, its impact goes beyond any rental activity of the business or commercial engagements irrespective whether reported under Schedules C, F or E in addition to whether flowing via losses and income from a given business engagement. According to Schenk (2017), the law does not apply to consistent C- Corporations; however, it has a limited application scenario in a tightly held corporation. Thus from the above-presented facts, it is evident that the Code section 469 passive activity loss rules will not apply for the Riccis to limit their ability to deduct the $25,000 total loss generated by their rental properties.
The Riccis do not adequately fulfill the following conditions granting them the opportunity to deduct the $25,000 total loss generated by their rental properties; Firstly, they have an ownership interest in the rental business. Secondly, they have "sufficient at-risk basis" holding debt/capital invested recourse. Finally, despite having a passive income, their loss is not classified as non-passive, and at the same time, they participate in the management of the passive activity. Marcia spent roughly 430 hours in the management of Property Two during the year. Larry also spent about 80 hours managing property one on the material year. At the same time, Marcia is the only one who managed the property this year. According to the stipulations of Section 469, Passive Activities, business activity or trade is considered passive activity under the condition that the owner is not engaged materially or participating materially.
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Section 469 further stipulates that distinct conditions guide the determination of material participation. According to the Section, fulfilling any one of the stated conditions underscores the activity as non-passive under that given year (Barclay, Heitzman & Smith, 2017). Thus, a tax-payer participates materially in a given activity by satisfying any one of the conditions below;
• The engagement in the activity is above 500 hours.
• The engagement makes up all participations in the goings on by all the persons under the stated year.
• He or she is engaged in the trade or activity for a period spanning over 100 hours for that specific tax year, and the engagement is higher than the participation of another individual.
• Aggregate involvement during the period surpasses five hundred hours. Substantial engagement is a situation whereby the tax-payer spends over a hundred hours within the stipulated tax year, although he or she does not fulfill any other condition for material engagement (Samansky & Smith, 2017).
• The individual engaged in the trade or activity over five of the ten tax years after the previous year under consideration.
• The individual has taken part in any three years before the year under consideration
• The tax-payer engages in the activity substantially, continuously, and regularly considering all the circumstances and facts (Stephens v. the US, 2018).
From the case given, the Riccis engages in the trade continuously and regularly. For example, on the material year, Marcia spent roughly 430 hours managing property two, and she was the only one managing the property on the material year. At the same time, Larry also spent about 80 hours undertaking the activities of property one even though it had a resident that was managing it and spent about 500 hours on the material year. Marcia spent over 500 hours, exceeding the stipulated 100 hours of significant activity of the material under engagement. Thus, their material participation it will end as a non-passive standing for the engagement under the given year.
Under Section 469 also, in case the tax-payer undertakes over 750 hours, the rental activity will be subjected as passive classification. Marcia does 500 hours while Larry undertakes only 80 hours, which fall short of 750 hours thus does not fulfil passive classification. The complexity arises in the total hour's input in the rental activity even though their losses are within the recommended $25,000 for the material year. However, since their gross income is less than one hundred and fifty thousand dollars, their losses will be considered as non-passive.
Conclusion
From the above-stipulated conditions spanning the fulfillment conditions under Section 469 Activities, the Riccis will deduct the $25000 total loss as a result of their rental property. Meeting and fulfilling all conditions and stipulations of Section 469 entails significant involvement and preparation by the Riccis. The above-outlined rules are multifaceted and at times difficult to comprehend and as such in order to benefit from the set stipulations of the provision, careful review of their activities and engagement with the rental property is very critical. Their material participation in the rental property participation was satisfied, and this resulted in non-passive standing because of their engagement with their rental property one and property two. Both engagements in the two properties are considered as a single unit or one business engagement. Thus, for example, when considering the total amount of hours engaged in the property, both their total hours will be put into consideration as one entity and not as separate entities.
References
Barclay, M. J., Heitzman, S. M., & Smith, C. W. (2017). Leverage and Taxes: Evidence from the Real Estate Industry. Journal of Applied Corporate Finance , 29 (4), 86-95. https://www.researchgate.net/profile/Clifford_Smith3/publication/323352002_Leverage_and_Taxes_Evidence_from_the_Real_Estate_Industry/links/5b201a21458515270fc582aa/Leverage-and-Taxes-Evidence-from-the-Real-Estate-Industry.pdf
Samansky, A. J., & Smith, J. C. (2017). Federal Taxation of Real Estate . Law Journal Press.
Schenk, D. H. (2017). Federal Taxation of S Corporations . Law Journal Press.
Stephens v. US , 884 F.3d 1151 (Fed. Cir. 2018).
