[Federal Register Volume 76, Number 228 (Monday, November 28, 2011)]
[Proposed Rules]
[Pages 72875-72878]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-30611]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-109369-10]
RIN 1545-BJ33


Passive Activity Losses and Credits Limited

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations regarding the 
definition of an ``interest in a limited partnership as a limited 
partner'' for purposes of determining whether a taxpayer materially 
participates in an activity under section 469 of the Internal Revenue 
Code (Code). These proposed regulations affect individuals who are 
partners in partnerships.

DATES: Written or electronic comments and requests for a public hearing 
must be received by February 27, 2012.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-109369-10), Room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
109369-10), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW., Washington, DC, or sent electronically, via the Federal 
eRulemaking Portal at http://www.regulations.gov/(IRS REG-109369-10).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Michala Irons, (202) 622-3050; concerning submissions of comments and 
requests for public hearing, Oluwafunmilayo Taylor, (202) 622-7180 (not 
toll free numbers).

SUPPLEMENTARY INFORMATION: 

[[Page 72876]]

Background

    Section 469(a)(1) limits the ability of certain taxpayers to deduct 
losses from passive activities. Section 469(b) permits passive losses 
disallowed in one year to be carried over to the next year. Section 
469(c)(1) provides that a passive activity means any activity which 
involves the conduct of any trade or business, and in which the 
taxpayer does not materially participate. Section 469(h)(1) provides 
that a taxpayer shall be treated as materially participating in an 
activity only if the taxpayer is involved in the operations of the 
activity on a basis which is regular, continuous, and substantial. The 
Treasury Department and the IRS promulgated temporary regulations under 
section 469 in 1988. See TD 8175, 53 FR 5686 (February 25, 1988). 
Section 1.469-5T(a) provides that an individual taxpayer shall be 
treated as materially participating in an activity for the taxable year 
if and only if:
    (1) The individual participates in the activity for more than 500 
hours during such year;
    (2) The individual's participation in the activity for the taxable 
year constitutes substantially all of the participation in such 
activity of all individuals (including individuals who are not owners 
of interests in the activity) for such year;
    (3) The individual participates in the activity for more than 100 
hours during the taxable year, and such individual's participation in 
the activity for the taxable year is not less than the participation in 
the activity of any other individual (including individuals who are not 
owners of interests in the activity) for such year;
    (4) The activity is a significant participation activity (within 
the meaning of Sec.  1.469-5T(c)) for the taxable year, and the 
individual's aggregate participation in all significant participation 
activities during such year exceeds 500 hours;
    (5) The individual materially participated in the activity 
(determined without regard to Sec.  1.469-5T(a)(5)) for any five 
taxable years (whether or not consecutive) during the ten taxable years 
that immediately precede the taxable year;
    (6) The activity is a personal service activity (within the meaning 
of Sec.  1.469-5T(d)), and the individual materially participated in 
the activity for any three taxable years (whether or not consecutive) 
preceding the taxable year; or
    (7) Based on all of the facts and circumstances (taking into 
account the rules in Sec.  1.469-5T(b)), the individual participates in 
the activity on a regular, continuous, and substantial basis during 
such year.
    Section 469(h)(2) presumptively treats losses from interests in 
limited partnerships as passive. Section 469(h)(2) provides that, 
except as provided in regulations, no interest in a limited partnership 
as a limited partner shall be treated as an interest with respect to 
which a taxpayer materially participates. Section 1.469-5T(e)(2) 
permits an individual taxpayer to establish material participation in a 
limited partnership but constrains the individual taxpayer to only 
three of the seven regulatory tests in Sec.  1.469-5T(a), (Sec.  1.469-
5T(a)(1), (a)(5), or (a)(6)).
    Section 1.469-5T(e)(3)(i) generally provides that a partnership 
interest shall be treated as a limited partnership interest if (A) such 
interest is either designated as a limited partnership interest in the 
limited partnership agreement or the certificate of limited 
partnership, without regard to whether the liability of the holder of 
such interest for obligations of the partnership is limited under 
applicable State law; or (B) the liability of the holder of such 
interest for obligations of the partnership is limited, under the law 
of the State in which the partnership is organized, to a determinable 
fixed amount (for example, the sum of the holder's capital 
contributions to the partnership and contractual obligations to make 
additional capital contributions to the partnership). However, even if 
the interest is characterized as a limited partnership interest under 
Sec.  1.469-5T(e)(3)(i), an exception under Sec.  1.469-5T(e)(3)(ii) 
applies if the individual is a general partner in the partnership at 
all times during the partnership's taxable year ending with or within 
the individual's taxable year (or portion of the partnership's taxable 
year during which the individual (directly or indirectly) owns such 
limited partnership interest) (the ``general partner exception''). If 
the general partner exception applies, the limited partnership interest 
will not be treated as such for the year in which the individual 
taxpayer is a general partner in the partnership. This allows the 
individual taxpayer to demonstrate material participation through any 
of the seven regulatory tests in Sec.  1.469-5T(a).
    Courts have concluded, in certain instances, that the holder of a 
limited liability company (LLC) interest is not treated as holding an 
interest in a limited partnership as a limited partner for purposes of 
applying the section 469 material participation tests. In Gregg v. 
U.S., 186 F.Supp.2d 1123 (D. Or. 2000), an Oregon district court 
concluded that, in the absence of regulations to the effect that an LLC 
member should be treated as a limited partner, the limited partner 
exception in section 469(h)(2) was not applicable to LLC members. In 
Garnett v. Comm'r, 132 T.C. 368 (2009), the Tax Court found that the 
taxpayers' ownership interests in limited liability partnerships and 
LLCs were not interests in limited partnerships because their interests 
fit within the general partner exception in Sec.  1.469-5T(e)(3)(ii). 
Shortly thereafter, in Thompson v. U.S., 87 Fed. Cl. 728 (2009), the 
Court of Federal Claims concluded that the regulations under section 
469(h)(2) require the taxpayer's ownership interest to be in a 
partnership under State law rather than a partnership under Federal 
income tax law. Accordingly, because an LLC member is not a limited 
partner under State law, the court concluded that section 469(h)(2) did 
not apply to an LLC member. Most recently, the Tax Court in Newell v. 
Comm'r, T.C. Memo. 2010-23, concluded that section 469(h)(2) did not 
apply to the managing member of an LLC and that the member fell within 
the general partner exception in Sec.  1.469-5T(e)(3)(ii). On April 5, 
2010, the IRS issued an Action on Decision acquiescing in the result 
only in Thompson v. U.S., AOD 2010-02, 2010-14 I.R.B. 515.

Explanation of Provisions

    The proposed regulations provide that an interest in an entity will 
be treated as an interest in a limited partnership under section 
469(h)(2) if (A) the entity in which such interest is held is 
classified as a partnership for Federal income tax purposes under Sec.  
301.7701-3; and (B) the holder of such interest does not have rights to 
manage the entity at all times during the entity's taxable year under 
the law of the jurisdiction in which the entity was organized and under 
the governing agreement. Rights to manage include the power to bind the 
entity. The proposed regulations provide rules concerning an interest 
in a limited partnership based on the purposes for which section 469 
was enacted, and the manner in which the provision is structured and 
operates within the Code. Accordingly, the rules concerning an interest 
in a limited partnership in the proposed regulations are provided 
solely for purposes of section 469 and no inference is intended that 
the same rules would apply for any other provisions of the Code 
requiring a distinction between a general partner and a limited 
partner.
    In Garnett v. Comm'r, supra, the Tax Court noted that Congress 
enacted

[[Page 72877]]

section 469(h)(2) to address the limitations on a limited partner's 
ability to participate in the control of the partnership's business. 
Under the Uniform Limited Partnership Act of 1916, limited partners 
could lose their limited liability protection if they participated in 
the control of the partnership. The regulations under section 469(h)(2) 
were drafted with these constraints in mind. Today, many states have 
adopted a variation of the Revised Uniform Limited Partnership Act of 
1985 (RULPA). Under RULPA, limited partners may participate in the 
management and control of the partnership without losing their limited 
liability. As a consequence, limited partners under RULPA are now more 
akin to general partners and LLC members with respect to their rights 
in the management of the entity. Under the Uniform Limited Liability 
Company Act of 1996, LLC members of member-managed LLCs do not lose 
their limited liability by participating in the management and conduct 
of the company's business. In Newell v. Comm'r, supra, the Tax Court 
noted that the managing member of the LLC at issue managed the day-to-
day operations of the LLC and was the ``substantial equivalent'' of a 
general partner. Recognizing that the original presumptions regarding 
the limitations on a limited partner's participation in the activities 
of the entity are no longer valid today, and also recognizing the 
emergence of LLCs, the proposed regulations eliminate the current 
regulations' reliance on limited liability for purposes of determining 
whether an interest is an interest in a limited partnership as a 
limited partner under section 469(h)(2) and instead adopt an approach 
that relies on the individual partner's right to participate in the 
management of the entity.
    The regulations are proposed to apply to taxable years beginning on 
or after the date of publication of the Treasury decision adopting 
these regulations as final regulations in the Federal Register.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866, as supplemented by Executive Order 13563. Therefore, a 
regulatory assessment is not required. It has also been determined that 
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) 
does not apply to this regulation, and because the regulation does not 
impose a collection of information on small entities, the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to 
section 7805(f) of the Code, these regulations will be submitted to the 
Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small business.

Comments and Requests Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and eight 
(8) copies) or electronic comments that are submitted timely to the 
IRS. All comments will be available for public inspection and copying. 
A public hearing will be scheduled if requested in writing by any 
person that timely submits written comments. If a public hearing is 
scheduled, notice of the date, time, and place for the public hearing 
will be published in the Federal Register.

Drafting Information

    The principal author of these proposed regulations is Michala 
Irons, Office of the Associate Chief Counsel (Passthroughs and Special 
Industries). However, other personnel from the Treasury Department and 
the IRS participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority:  26 U.S.C. 7805 * * *

    Par. 2. Section 1.469-0 is amended by:
    1. Revising the entries for Sec.  1.469-5(a), (b), (c), (d), and 
(e).
    2. Removing the entries for Sec.  1.469-5T(e)(1), (e)(2), and 
(e)(3).
    The revisions read as follows:


Sec.  1.469-0  Table of contents.

* * * * *


Sec.  1.469-5  Material participation.

    (a) through (d) [Reserved].
    (e) Treatment of an interest in a limited partnership as a limited 
partner.
    (1) In general.
    (2) Exceptions.
    (3) Interest in a limited partnership as a limited partner.
    (i) In general.
    (ii) Individual holding an interest other than an interest in a 
limited partnership as a limited partner.
    (4) Effective/applicability date.
* * * * *
    Par. 3. In Sec.  1.469-5, paragraphs (a), (b), (c), (d), and (e) 
are revised to read as follows:


Sec.  1.469-5  Material participation.

    (a) through (d) [Reserved].
    (e) Treatment of an interest in a limited partnership as a limited 
partner--(1) In general. Except as otherwise provided in this paragraph 
(e), an individual shall not be treated as materially participating in 
any activity in which the individual owns an interest in a limited 
partnership as a limited partner (as defined in paragraph (e)(3)(i) of 
this section) for purposes of applying section 469 and the regulations 
thereunder to--
    (i) The individual's share of any income, gain, loss, deduction, or 
credit from such activity that is attributable to an interest in a 
limited partnership as a limited partner; and
    (ii) Any gain or loss from such activity recognized upon a sale or 
exchange of such an interest.
    (2) Exceptions. Paragraph (e)(1) of this section shall not apply to 
an individual's share of income, gain, loss, deduction, and credit for 
a taxable year from any activity in which the individual would be 
treated as materially participating for the taxable year under 
paragraphs (a)(1), (a)(5), or (a)(6) of Sec.  1.469-5T if the 
individual did not own an interest in a limited partnership as a 
limited partner (as defined in paragraph (e)(3)(i) of this section) for 
such taxable year.
    (3) Interest in a limited partnership as a limited partner--(i) In 
general. Except as provided in paragraph (e)(3)(ii) of this section, 
for purposes of section 469(h)(2) and this paragraph (e), an interest 
in an entity shall be treated as an interest in a limited partnership 
as a limited partner if--
    (A) The entity in which such interest is held is classified as a 
partnership for Federal income tax purposes under Sec.  301.7701-3; and
    (B) The holder of such interest does not have rights to manage the 
entity at all times during the entity's taxable year under the law of 
the jurisdiction in which the entity is organized and under the 
governing agreement.
    (ii) Individual holding an interest other than an interest in a 
limited partnership as a limited partner. An individual shall not be 
treated as holding an interest in a limited partnership as a limited 
partner for the individual's taxable year if such

[[Page 72878]]

individual also holds an interest in the partnership that is not an 
interest in a limited partnership as a limited partner (as defined in 
paragraph (e)(3)(i) of this section), such as a state-law general 
partnership interest, at all times during the entity's taxable year 
ending with or within the individual's taxable year (or the portion of 
the entity's taxable year during which the individual (directly or 
indirectly) owns such interest in a limited partnership as a limited 
partner).
    (4) Effective/applicability date. This section applies to taxable 
years beginning on or after the date of publication of the Treasury 
decision adopting these rules as a final regulation in the Federal 
Register.
* * * * *
    Par. 4. Section 1.469-5T paragraph (e) is revised to read as 
follows:


Sec.  1.469-5T  Material participation (temporary).

* * * * *
    (e) Treatment of Limited Partners. [Reserved]. See Sec.  1.469-5(e) 
for rules relating to this paragraph (e).
* * * * *
    Par. 5. Section 1.469-9 paragraph (f)(1) is revised to read as 
follows:


Sec.  1.469-9  Rules for certain rental real estate activities.

* * * * *
    (f) Limited partnership interests in rental real estate 
activities--(1) In general. If a taxpayer elects under paragraph (g) of 
this section to treat all interests in rental real estate as a single 
rental real estate activity, and at least one interest in rental real 
estate is held by the taxpayer as an interest in a limited partnership 
as a limited partner (within the meaning of Sec.  1.469-5(e)(3)), the 
combined rental real estate activity of the taxpayer will be treated as 
an interest in a limited partnership as a limited partner for purposes 
of determining material participation. Accordingly, the taxpayer will 
not be treated under this section as materially participating in the 
combined rental real estate activity unless the taxpayer materially 
participates in the activity under the tests listed in Sec.  1.469-
5(e)(2) (dealing with the tests for determining the material 
participation of a limited partner).
* * * * *

Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2011-30611 Filed 11-25-11; 8:45 am]
BILLING CODE 4830-01-P