New Case Involving the Passive Loss Rules and Grouping of Activities

The passive loss rules apply to activities that involve the conduct of a trade or business and the taxpayer does not materially participate in the activity or in rental activity on a basis which is regular, continuous and substantial. If the passive loss rules apply, deductions (losses) from passive trade or business activities, to the extent the deductions exceed income from all passive activities, may not be deducted against other income (non-passive activity gains). For farmers, the passive loss rules are likely to come into play in situations where the farmer is a passive investor in a separate business venture apart from the farming operation. In that case, the losses from the venture cannot be used to offset the income from the farming operation - unless the farmer can group the activities together as a single economic unit for passive loss purposes. If grouping can be done, the farmer's material participation in the farming activity will count as material participation in the passive business, and the losses will offset the farming income.

Any reasonable method for making the grouping determination can be utilized, but certain factors are given the greatest weight in determining whether activities should be grouped or kept separate - (1) similarities or differences in types of businesses; (2) extent of common control; (3) extent of common ownership; (4) geographic location; and (5) business interdependencies.

A recent Tax Court case illustrates the application of the passive loss rules and the activities that can be grouped. In Senra v. Comm’r., T.C. Memo. 2009-79, the taxpayer was a majority owner in a C corporation that was engaged in retail sales of granite and marble. The taxpayer was materially involved in the operations of the C corporation and received wage income. The taxpayer also was the sole owner of a limited liability company (LLC) that rented a warehouse to the C corporation. The LLC had passive rental losses that flowed through to the taxpayer, and the taxpayer wanted to group his active participation in the C corporation with his passive activities in the LLC for purposes of satisfying the material participation test of the passive loss rules. However, the Tax Court ruled that Treas. Reg. §1.469-4(d)(5)(ii) limited the aggregation of the activities. The taxpayer argued that the Regulation only applied when unrelated activities are grouped, but the Tax Court rejected that argument. Thus, because the rental activities in the LLC were per se passive irrespective of whether the taxpayer materially participated in them, the taxpayer had no passive income and the losses were not deductible.

The election to group activities is made by filing a statement with the taxpayer's original income tax return for the taxable year. The following are sample election statements. One is for a grain storage activity and the other is for a hog breeding facility.

Grouping of activities (grain storage) (pdf)
Grouping of activities (hog breeding) (pdf)