What does "materially participate" mean?

In order to materially participate, you have to meet one of several tests to determine if a business is or is not a passive activity. In general, material participation includes being involved in the operations of an activity on a standard, continual, and significant basis.

The IRS instructions define material participation as the following:
All determinations of material participation are based on your participation during the partnership's tax year.

If you are an individual (either general partner or a limited partner who owned a general partnership interest at all times during the tax year), you materially participated in an activity only if one or more of the following apply:
  • You participated in the activity more than 500 hours during the tax year.
  • Your participation in the activity for the tax year was substantially all the participation in the activity of all individuals (including individuals who are not owners of interests in the activity) for the tax year.
  • You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who were not owners of interest in the activity) for the tax year.
  • The activity was a significant participation activity for the tax year and you participated in all significant participation activities during the year (including activities outside the partnership) for more than 500 hours.
  • You materially participated in the activity for any 5 of the prior 10 tax years (not necessarily consecutive).
  • The activity was a personal service activity and you materially participated in the activity for any 3 prior tax years (not necessarily consecutive).
    A personal service activity involves the performance of personal services in the field of health, law, engineering, architecture, accounting, performing arts, actuarial science, consulting, and any other trade or business where capital is not a material income producing factor.
  • Based on all of the circumstances and facts, you participated in the activity on a regular, continuous, and substantial basis for more than 100 hours during the tax year.

What is a limited partner?

A limited partner is a partner in a partnership formed under a state limited partnership law, whose personal liability for partnership debts is limited to the amount of money or other property that the partner contributed or is required to contribute to the partnership.

Can a limited partner materially participate in an activity?

If you are a limited partner, you do not materially participate in an activity unless you meet one if the following:
  • You participated in the activity more than 500 hours during the tax year.
  • You materially participated in the activity for any 5 of the prior 10 tax years (not necessarily consecutive).
  • The activity was a personal service activity and you materially participated in the activity for any 3 prior tax years (not necessarily consecutive).
    A personal service activity involves the performance of personal services in the field of health, law, engineering, architecture, accounting, performing arts, actuarial science, consulting, and any other trade or business where capital is not a material income producing factor.

What is passive activity?

A passive activity is any business activity in which the taxpayer does NOT materially participate.

How is my passive income/loss determined?

If you don't materially participate in a business activity, your passive income or loss is calculated by matching income and expenses of the activity.

Portfolio Income (interest, dividends, annuities, and royalties from property held for investment) isn't included when determining passive income or loss.

Who qualifies to be a real estate professional?

In order to be considered a real estate professional, you must meet both of the following criteria:
  • More than half of your personal services you performed in any businesses or trades were performed in real property businesses in which you materially participated.

    A real property trade or business is any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, brokerage trade, or business. 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.
  • You performed more than 750 hours of services during the year in real property trades or businesses in which you materially participated.

What is considered material participation?

You are considered a material participant in an activity if you meet one of the following criteria:
  • During the tax year, you participated in the activity for more than 500 hours.
  • Your participation in the activity during the tax year constituted a substantial amount of all the participation in the activity from all individuals and non-owners.
  • During the tax year, you participated in the activity for more than 100 hours and your participation is at least as much as that of any other person.
  • The Significant Participation Test: During the tax year, you participated in many different activities, none of which, by themselves, constitute material participation. However, if you spend at least 100 hours in each activity and the total hours of all activities are greater than 500 hours, then you are considered a material participant in each activity.
  • You materially participated in the activity for any five tax years within the 10 tax years preceding 2013. The five tax years don't need to be consecutive.
  • In a personal service activity, you materially participated for any three tax years (not necessarily consecutive) preceding 2013. Personal service activities are defined as any trade or business in which capital is not a substantial income producing factor. Examples include, but are not limited to the following: professions of health, law, engineering, accounting, the performing arts, architecture, and consulting.
  • You participate in the activity on a regular, substantial and continuous basis. According to the IRS, you do not qualify for this if you participate less than 100 hours in the activity.

What are passive loss carryovers?

If you were unable to deduct all of your losses from a K-1 on previous year tax returns, the passive loss that wasn't deducted carries forward to your current tax return.

If you have passive income from your K-1s, part or all of the prior year passive losses can be used on this year's tax return. Otherwise, the passive losses will be reported again on your Form 8582 and will carry forward to next year. Passive losses continue to carry forward until you either have passive income to use the losses or you dispose of your ownership interest. In the year you dispose of your ownership interest, all passive losses including carryforwards are deducted.

Look for your prior year passive loss carryovers on Form 8582 of your prior year tax returns. Unallowed losses on Form 8582 Worksheets 5, 6 or 7 are the losses that carry forward to the next year.

How do I enter unreimbursed partnership expenses?

You can deduct unreimbursed ordinary and necessary partnership expenses you paid on behalf of the partnership if you were required to pay these expenses under the partnership agreement (except amounts deductible only as itemized deductions, which you must enter on Schedule A).

Enter your Partnership K-1 first, then create a second partnership record to enter the unreimbursed partnership expenses. Enter UPE (unreimbursed partnership expenses) as the Name of Partnership. Enter the amount of the unreimbursed job expenses as a loss on the Ordinary Business Income (Loss) line with a negative sign in front of the expense number so it is treated as a loss. This will make the unreimbursed partnership expenses show up on a separate line than your regular partnership K-1 income on Schedule E page 2 of your tax return which is how the IRS wants it shown.

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