1 TD 8175 2 25 88 Limitations on Passive Activity Losses and Credits AGENCY Internal Revenue Service Treasury ACTION Temporary regulations SUMMARY This document contains temporary regulations relating to the limitations on passive activity losses and passive activity credits Changes to the applicable tax law were made by the Tax Reform Act of 1986 The temporary regulations affect taxpayers subject to the limitations on passive activity losses and passive activity credits and provide them with the guidance needed to comply with the law The text of the temporary regulations set forth in this document also serves as the text of the proposed regulations for the notice of proposed rulemaking on this subject in the Proposed Rules section of this issue of the Federal Register EFFECTIVE DATE Except as otherwise provided in 1 469 11T the temporary regulations are effective for taxable years beginning after December 31 1986 FOR FURTHER INFORMATION CONTACT Michael J Grace of the Legislation and Regulations Division Office of Chief Counsel Internal Revenue Service 1111 Constitution Avenue NW Washington DC 20224 Attention CC LR T 202 566 3288 not a toll free call SUPPLEMENTARY INFORMATION Background This document amends the Income Tax Regulations 26 CFR Part 1 to provide temporary rules relating to the limitations on passive activity losses and passive activity credits the passive loss and credit limitations The temporary regulations reflect the amendment of the Internal Revenue Code of 1986 the Code by sections 501 and 502 of the Tax Reform Act of 1986 Pub L 99 514 100 Stat 2233 and 2241 which added section 469 Section 469 disallows the passive activity loss and the passive activity credit for the taxable year Scope of the Regulations These regulations provide general rules for applying the the passive loss and credit limitations Section 1 469 1T contains rules relating to the disallowance of the passive activity loss and passive activity credit the taxpayers to whom the passive loss and credit limitations apply the general effect of section 469 on the treatment of items of income gain loss deduction and credit from passive activities definitions of essential terms including passive activity trade or business activity and rental activity the treatment of certain losses from oil and gas working interests the application of the passive loss and credit limitations to C corporations including rules relating to the application of the material participation standard the computation of net active income and the application of section 469 to affiliated groups of corporations filing consolidated returns and the treatment of spouses filing joint returns Section 1 469 2T contains rules for computing the passive activity loss including rules for identifying passive activity gross income passive activity deductions and portfolio income and related deductions 2 and rules including rules pursuant to section 469 l 1 2 and 3 requiring that income from certain passive activities be treated as income that is not from a passive activity Section 1 469 3T contains rules for computing the passive activity credit including rules relating to the identification of credits subject to section 469 and the computation of the regular tax liability allocable to passive activities Section 1 469 5T contains rules defining the term material participation for purposes of section 469 and the regulations thereunder Section 1 469 11T explains the effective date of section 469 and the regulations thereunder and provides guidance under the transitional rule for losses and credits from preenactment interests in passive activities Future regulations will provide rules identifying economic undertakings that are treated as separate activities for purposes of section 469 and the regulations thereunder to be located in 1 469 4T rules relating to the treatment of losses allowable under section 469 g upon certain dispositions of interests in activities to be located in 1 469 6T rules relating to the treatment of certain self charged expenses and related income to be located in 1 469 7T rules relating to the application of section 469 to trusts estates and their beneficiaries to be located in 1 469 8T rules relating to the application of the 25 000 allowance under section 469 i for passive activity losses and credits attributable to certain rental real estate activities to be located in 1 469 9T rules relating to the treatment of publicly traded partnerships under section 469 k to be located in 1 469 10T and rules relating to the application of the passive loss and credit limitations in the case of former passive activities and corporations that change status from year to year i e corporations that cease to be personal service corporations corporations that cease to be closely held corporations and C corporations that become S corporations to be located in 1 469 1T k Significant Policy Issues I Effect of Section 469 on Other Provisions A Items of Income or Gain Section 1 469 1T d 1 provides that the characterization of items of income or deduction as passive activity gross income or passive activity deductions does not affect the treatment of any item of income or gain under any provision of the Code other than section 469 Thus for example an item of capital gain from a passive activity that is treated under the regulations as an item of passive activity gross income is taken into account in determining both the passive activity loss and credit for the taxable year and the allowable capital loss for the taxable year B Items of Deduction Section 1 469 1T d 3 provides that except as otherwise provided by regulations a deduction that is disallowed for a taxable year under section 469 is not taken into account as a deduction that is allowed for the taxable year in computing the amount subject to any tax imposed by subtitle A of the Code Thus for example if a deduction is disallowed under section 469 for purposes of computing taxable income subject to income tax the deduction is not taken into account in computing the taxpayer s net earnings from selfemployment for purposes of the tax on self employment income imposed under chapter 2 of the Code II Definition of Passive Activity A Trade or Business Activity Under section 469 c 1 an activity which involves the conduct of a trade or business and in which the taxpayer does not materially participate is a passive activity Section 1 469 1T e 2 generally defines the term trade or business activity