11 Nov Tests for Material Participation IRC 469(h) Reg. 1.469-5T
Material participation is regular, consistent and substantial personal involvement in operations. It is required in businesses, farms, rental real estate owned by real estate professionals, most vacation rentals, hotels, motels, and B&B’s, etc.. Basically most anything reported on IRS form K-1 Line 1 for partnership or ‘S’ Corp businesses should evaluate material participation issues.
For the most part if a tax payer is ‘materially participating’ in an investment activity then losses are allowed in full. The investment is not passive. If you are not ‘materially participating’ in an investment activity then the investment is considered passive and losses are reported as passive activity losses on IRS form 8582. On this form no losses are deductible without passive income.
If you are a limited partner in an investment you are considered to have materially participated if you meet one of the following criteria:
- You (or your spouse) worked more than 500 hours through out the course of the year in the business.
- You ‘materially participated’ in the business for 5 of the last 10 years.
- If a personal service activity you materially participated for any 3 prior years.
Additionally if you are an LLC managing member you are considered to have materially participated if you met any one of the above criteria or:
- You or your spouse performed ‘most’ of the work.
- You worked more than 100 hours but no one else worked more than you.
- You have several passive business activities in which you claim to materially participate between 100-500 hours each, and the total participation exceeds 500 hours. (not applicable to rentals)
- Facts and circumstances indicate that you materially participated, for example you did not hire a ‘manager’.