[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