Is that Deductible? A Look at Commonly Asked Business

Is That Deductible? A Look at Commonly Asked Business

DeductionsNick Preusch, CPA, JD, LLM

IRS Audits

• Business audits are typically balance sheet driven.

• Once IRS can tie the balance sheet down, they know everything else will go into the income statement.

LUQ

• Good to know what the IRS is looking for:

• IRS looks at LUQs:• Large

• Unusual

• Questionable Items

Large Items

• Large depends on the business. $5,000 is large for a business with gross receipts of $10,000, but $5,000 is small for a business with gross receipts of $100,000

Unusual Items

• Things that you typically would not see for a business:• Why would a day trader have a ton of auto miles?

• Why would an Uber driver have meals?

Questionable Items

• These are things that you take a second look at.

S Corporation Reimbursements

• S corporations treat owners as employees.

• Often a business will not title assets in the business name and keep them personally titled.

• This creates rental income or unreimbursed employee expenses.

• Unreimbursed employee expenses are no longer deductible

• Solution: Create an accountable plan to deduct these expenses on the S Corp return

S Corp Reimbursements

• If going the rental route, you can rent your home to the S Corporation. If the rental is less than 14 days in a year, the income is not reportable

S Corp – Health Insurance

• S Corp pay the premiums or reimburse shareholder

• Add the premiums to W-2, but not subject to Social Security tax

• Self-employed Insurance Deduction

• Often people will not run it through the W-2. Should be corrected now with IRC 199A.

S Corp/C Corp - Compensation

• IRC 162(a) requires reasonable compensation.

• Watson case

• Key factors to look at.

• S Corp wants low compensation, C Corps wanted high (but changed now with TCJA?)

Paying Kids

• Can pay kids to reduce income as long as they are actually doing work

• Keep a time sheet for them

• Money must go into an account in their name, like a 529 or a Roth IRA.

• 529 can be used for private school now, so its like they’re paying their own tuition

Vacations

• Deduct on Schedule A – Misc expense? - NO

Home Improvements

• Deduct on Schedule A as Misc. deduction? No

Inventories

• TCJA allows for change of accounting method to treat inventories as immaterial materials and supplies.

• These fall under the de minimis safe harbor provision - $2,500/$5,000

Meals and Entertainment

• New rules

• Meals will eventually be non-deductible

• Entertainment is not deductible at all

• Need to change chart of accounts

Luxury Expense Items

• IRC 162 – ordinary and necessary

• Any over the top expenses can be limited

• Dr. with 5 luxury cars

College Football Tickets

• Old law allowed a charitable deduction who right to buy college sports tickets.

• New law disallows this deduction.

• Remainder of ticket expenses will be non-deductible as entertainment

Country Club Dues

• All club dues are now non-deductible. This includes airline clubs as well.

• Only business club dues like rotary are still deductible

Charitable Expenses

• Many businesses donate property

• May have a qualified appraisal requirement

State Taxes

• Businesses can accrue their state taxes payable when they prepare their tax return even though taxes are not paid until the following year.

Depreciation

• 100% Bonus

• IRC 179

• IRC 179 v. Bonus – state issues, NOLs

Rental Depreciation

• People often forget to depreciate their rentals

• Can do a 3115 to claim all the depreciation in one year, usually the year of sale

Small Taxpayer Safe Harbor for Repairs

• $1,000,000 unadjusted basis of buildings

• Deduct capital improvements with the lesser of: 2% of unadjusted basis of building or $10,000

QBI Calculation

• https://www.pbmares.com/qualified-business-income-qbi-deduction-flowchart/

https://www.pbmares.com/qualified-business-income-qbi-deduction-flowchart/

Trade or Business

• Reg 1.199A-1(b) provides us the definition as:

• Trade or business means a section 162 trade or business other than the trade or business of performing services as an employee. In addition, rental or licensing of tangible or intangible property (rental activity) that does not rise to the level of a section 162 trade or business is nevertheless treated as a trade or business for purposes of section 199A, if the property is rented or licensed to a trade or business which is commonly controlled under § 1.199A-4(b)(1)(i) (regardless of whether the rental activity and the trade or business are otherwise eligible to be aggregated under § 1.199A-4(b)(1)).

Trade or Business

• This means rental activities are not going to count towards the 20% deduction unless they rise to the level of a trade or business.

• Need to look at Net Investment Income Tax rules as a guide

• Just because you are a real estate pro, does not mean it’s a trade or business

• IRS looks at business type activities. Once of the big things is issuing 1099s. Rentals do not have to, but trade or businesses do.

Self-Rentals

• The proposed regulations extend the definition of trade or business for purposes of section 199A beyond section 162 in one circumstance. Solely for purposes of section 199A, the rental or licensing of tangible or intangible property to a related trade or business is treated as a trade or business if the rental or licensing and the other trade or business are commonly controlled under proposed § 1.199A-4(b)(1)(i). It is not uncommon that for legal or other non-tax reasons taxpayers may segregate rental property from operating businesses. This rule allows taxpayers to aggregate their trades or businesses with the associated rental or intangible property under proposed § 1.199A-4 if all of the requirements of proposed § 1.199A-4 are met. In addition, this rule may prevent taxpayers from improperly allocating losses or deductions away from trades or businesses that generate income that is eligible for a section 199A deduction.

Self-Rentals – Common Control

• The same person or group of persons, directly or indirectly, owns 50 percent or more of each trade or business to be aggregated, meaning in the case of such trades or businesses owned by an S corporation, 50 percent or more of the issued and outstanding shares of the corporation, or, in the case of such trades or businesses owned by a partnership, 50 percent or more of the capital or profits in the partnership;

Self-Rentals Example

• S Corporation A is an IRC 162 trade or business owned by Amy and Bill, 50-50. Amy and Bill also own Building A, LLC 50-50. Building A is rented to S Corporation A as a self-rental but does not rise to an IRC 162 trade or business. Under Reg. 1.199A-4(b)(1)(i), there is common control and Building A is a considered a trade or business.

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Basics

• Basic rule – Passive losses can only offset passive income

• Gain on sales of assets

• Passive vs. non-passive• Depends on material participation

• Except for rentals, which are per se passive• Several exceptions that all us to make a rental non-passive

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What is not passive?

• Rental income from a building leased to a business where TP works Reg. 1.469-2(f)(6)

• Rental income from leased land Reg. 1.469-2T(f)(3)

• Income from land, a building, or other property held for investment IRC 469(e)(1)(A)(ii)(II)

• Gain on stocks and bonds IRC 469(e)(1)(A)(ii)(II). But see Reg. 1.469-2T(e)(3) if 1120S had a passive activity.

• Royalties IRC 469(e), Reg. 1.469-2T(c)(3)(i)(A)

• Covenant not to compete Reg. 1.469-2(c)(7)(iv)

• Interest, dividends, gain on stocks and bonds IRC 469(e)(1)

• Guaranteed payments from a partnership Reg. 1.469-2(e)(2)(ii)

• Income from business if TP materially participated any 5 of the last 10 years Reg. 1.469-5T(a)(5)

• Income from a personal service activity if TP materially participated any 3 prior yrs Reg. 1.469-5T(a)(6)

• Any activity in which the spouse materially participated IRC 469(h)(5)

• K-1 line 1 income from a partnership which a trader in stocks and bonds Reg. 1.469-1T(e)(6); NAICS 523900

• Income from an activity which is in the business of lending money, i.e. financing Reg. 1.469-2T(f)(4)

• Property sold, but not rented in year of sale, i.e. not leased during yr Reg. 1.469-2T(c)(2)(i)(A)(iii)

• Gain on any activity if it is not a passive activity in the year sold Reg. 1.469-2T(c)(2)(i)(A)(iii)

• Patents, copyrights, literary, musical or artistic composition or any other intangible if TP’s personal services contributed to the creation Reg. 1.469-2T(c)(7)

• Leasing “rights” are an intangible. Not a rental activity. IRC 469(j)(8) holds a rental is tangible property.

• K-1 line 4(e) for 2003; K-1 line 8 or 9 for 2004 and later – these lines are always portfolio income.

• Flows to Sch. D line 12, which is always portfolio income, i.e. not passive income.

• K-1 line 1 income from a partnership which is a trader in stocks & bonds NAICS 523900 Reg. 1.469-1T(e)(6)

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Burden and Records

• It is the taxpayer’s burden to prove he materially participated in an activity. Reg. 1.469-5T(f)(4) requires the taxpayer to provide (1) services performed and (2) hours attributable to those services. If services or time are not reasonable, IRS can disallow losses in the absence of contemporaneous supporting documentation. If services are provided but not hours attributable to each of the services, we can disallow losses as the taxpayer has not met the recordkeeping rules of Reg. 1.469-5T(f)(4). Managerial authority does not necessarily mean the taxpayer materially participated. Reg. 1.469-5T(a) holds that the taxpayer materially participates if and only if he meets one of seven tests, the most common being the 500 hour test.

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Material Participation 7 Tests

• Did TP and/or spouse work more than 500 hours a year in the business?

• Did TP do most of the work?

• Did TP work more than l00 hours and no one worked more hours?

• Did TP have several passive business activities in which he worked between 100-500 hours each and the total hours are more than 500 hours? This test is not applicable to rentals or limited partners.

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• Basic tax law for significant participation activities• A significant participation activity (SPA) is a passive

business in which the taxpayer works between 100 to 500 hours. If the sum of hours for all SPA’s is more than 500 hours for the year, income or losses from all SPA’s are nonpassive - and do not go on F8582 line 3a or 3b. SPA’s do not need to be related activities. However, If TP materially participates in the activity under any of the tests in Reg. 1.469-5T(a), it is not a SPA.

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• Activities that are not significant participation activities • Rental real estate - Reg. 1.469-5T(c)(1)(i) holds that a SPA must be a trade or business. Reg. 1.469-4(b)(1) holds that the

definition of a business does not include a rental.

• Equipment rentals and other leasing activities

• Limited partner (K-1) - See Reg. 1.469-5T(e)(2). SPA test in 1.469-5T(a)(4) is not available to limited partners.

• Partnership that trades in stocks and bonds Reg. 1.469-1T(e)(6)

• Investment activities Not a business.

• Any activity in which TP does not work at least 100 hours, excluding investor-type time and work not customarily done by an owner.

• A business in which the taxpayer does most of the work.

• A business in which the taxpayer materially participated 5 of the prior 10 years, even if he does nothing in the current year -Reg. 1.469-5T(a)(5)

• A business activity in which the taxpayer worked more than 500 hours during the year - Reg. 1.469-5T(a)(1) holds if TP works more than 500 hours, he materially participated.

• Any activity in which TP does not have an ownership interest at the time the work is done. TP may work in a business, but not own any of the activity. Final Reg. 1.469-5(f)(1)

• A publicly traded partnership

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• Did TP materially participate in activity for any 5 of the last l0 years?

• Did TP materially participate in a personal service activity for any 3 prior years?

• Personal service activity =health, law, engineering, architecture, accounting, actuarial science, performing arts & consulting.

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• Do facts and circumstances indicate TP materially participated? Test cannot be used unless TP worked more than 100 hours for the year.

• Also does not apply if • (1) anybody was paid in connection with managing the

activity; or

• (2) if any person spent more hours than TP managing the activity.

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Material Participation 7 Tests – Limited Partners

• Basic tax law impacting limited partners and passive activity losses (IRC § 469)• Reg. 1.469-5T(e) permits only 3 tests for material participation of a limited partner in a business, If the

taxpayer is a real estate professional and owns a rental activity via a limited partnership interest, the taxpayer can only use the 3 tests for material participation in the rental. Recent court decisions have allowed LLC members to use all 7 material participation tests. A single member LLC (a disregarded entity) can use all 7 tests for material participation.

• Only 3 tests available to a limited partner:• TP materially participated if he meets one of the following -

• Did taxpayer and/or spouse work more than 500 hours a year in the business? Reg. 1.469-5T(a)(1)

• Did taxpayer materially participate in activity for any 5 of the last l0 years? Reg. 1.469-5T(a)(5)

• Did TP materially participate in a personal service activity for any 3 prior years? Reg. 1.469-5T(a)(6)

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Self-Rentals

• Self-Rentals that have positive gross income are reclassified from passive to non-passive

• Do not reclassify a self-rental loss. It stays whatever it is.

Grouping – Reg. 1.469-4(d)

• Rental Activities• Cannot group under 1.469-4(d) unless:

• Rental activity is insubstantial OR

• Owned in identical percentage with the business and leased back to the business

• Rental and Leasing can never be grouped with a C Corporation


• Effective tax strategy for client with self-rental that has a loss.

• Allows client to take the loss against the business income.


• Grouping rules may change

• Under proposed IRC 199A Regulations, the IRS asked about consolidating the grouping rules all into the IRC 199A aggregation rules, so stay tuned.

Why Do We Care?

• Passive losses can only be offset by passive income.

• Example:• $20,000 PAL

• $100,000 in W-2 income

• $20,000 is not deductible, unless exception applies

When Can We Deduct PAL’s without PAI

• Can deduct current and carryover PALs when:• 100% of activity sold

• Sold to an unrelated party

• All gain or loss is realized and recognized• Example, not allowed in 1031 exchange

Rental Activity

• Rental Activities are per se passive

• Material participation does not matter

• Allowed $25,000 loss on return, but is reduced with higher AGI• MAGI starts at $100,00

• Gone if MAGI over $150,000

What is not a rental

• Average customer use is 7 days or less. If lessee (renter) has a recurring right to use property, lease period is not 7 days or less, but the entire year, i.e. 365 days, or more.

• Average customer use is 30 days or less and significant personal services are provided

• Extraordinary personal services are provided in connection with property Ex: hospital

• Rental is incidental to a non-rental activity. Rents are less than 2% of adjusted basis or FMV.

• Property is available during defined business hours for nonexclusive use by customers.

• Property is provided (contributed) to a partnership or S corporation. If property is leased (instead of contributed to a 1065 or 1120S, this exception doe not apply.

Real Estate Pros

• Real Estate Pro status allows taxpayer to treat per se passive income as non-passive

• Full deduction for properties they materially participate in• More than half of taxpayers personal services in all businesses are in real

property business

• Taxpayer worked more than 750 hours on real property business

• Taxpayer materially participated in each rental

Real Pro Example

• Taxpayer has two rental properties• Works 250 hours on one without material participation, has loss of $40,000

• Works 500 hours on the other one with material participation, has loss of $60,000

Real Property Trade or Business

• Real Property Development

• Construction

• Acquisition

• Conversion

• Rental Operation, or Management

• Leasing

• Brokerage

Applicable Material Participation Rules for Rentals• 500 hours

• TP do most work on property

• TP work more than 100 hours and no one worked more

• Material participation in 5 of last 10 years

• Facts and circumstances (not used is ANYONE was paid money to manage)

Hours That Don’t Count

• Hours before buying the property.. Such as searching for property to buy

• Reading reports, making budgets, phone calls, visits, preparing 1040, organizing records unless TP is involved day to day

• Work not customarily done by an owner

• Travel Time

• Time on property held for investment

• Construction time

• Renovation hours if not leased at that time

• Exaggerated time

Where to Report

• If TP is a RE Pro• Properties he materially participates in do not go on the Form 8582

• If he does not materially participate in rent, losses go on Form 8582

Material Participation - Grouping

• The material participation rules apply to each separate rental.. Unless you group under Reg 1.469-9(g)

• Once filed, binds all future years

• All real estate rentals must be grouped – including future rentals

Grouping

• Election effective for all years• Only need to make election once

• Copy should be kept in a perm file

Down Side of Grouping

• Complete disposition rules do not qualify if the TP sells 1 real estate property that has been grouped with others• Suspended losses then are only up to the income received from sale

RE Pro – PY

• Losses in years before becoming a RE Pro are not triggered just because he comes a RE Pro• Needs a qualifying disposition

• $25,000 offset;

• Now non-passive rentals produce income; or

• Passive income

When to Ask About PALs

• Distance TP lives from the activity

• Limited Partners

• Low ownership percentages

• No Compensation – especially no guaranteed payments

When to Ask About PALs

• Limited Partners/LLC Members:• Did taxpayer perform most of the work?

• Did taxpayer work more than l00 hours and no one worked more hours?

• Did taxpayer have several passive business activities in which he participates between 100-500 hours each, and the total participation exceeds 500 hours? Test is not applicable to rentals or a limited partner.

• Do facts and circumstances indicate taxpayer is materially participating? Test does not apply unless taxpayer worked more than 100 hours a year. Furthermore, it does not apply if (1) any person received compensation in connection with managing the activity; or (2) if any person spent more hours than taxpayer managing the activity.

Leased Land Exception

• Reg. 1.469- 2T(f)(3): Net rental income from property in which less than 30% of the unadjusted basis is depreciable is nonpassive. It is not passive income and should not be on Form 8582 line 1a, where it erroneously triggers unrelated passive losses. Similarly, gain on the sale of leased land is also nonpassive. Only net income is recharacterized as nonpassive. If there is a net loss, it generally remains passive.

• IRC 469(e)(1)(A)(ii)(II): Gain on the sale of property held for investment is not passive income. Gain on Sch. D from the sale of land held for investment is not passive income.

Royalties

• IRC 469(e) and Reg. 1.469-2T(c)(i)(A) provide that royalties are nonpassive--they are portfolio income - if an individual taxpayer’s personal efforts significantly contributed to the creation of a patent, copyright or literary, musical or artistic composition

Royalties

• There is a single rare exception in Reg 1.469-2T(c)(3)(ii)(E) that provides that royalties derived in the ordinary course of a business of licensing intangible property may be passive income. This exception applies to taxpayers who personally own or invested in a partnership or S corporation conducting a business which licenses intangible property. Royalty income can be passive income under Reg.1.469-2T(c)(3)(ii)(E) only if

• Derived in the ordinary course of a business (not a rental) which licenses intangible property, AND

• The person created the property or performed substantial services or incurred substantial costs, AND

• He does not materially participate in the business in the current year under exam.

• He does not materially participate in the business in the current year under exam. (Note: if taxpayer materially participated in any 5 of the prior 10 years the income is nonpassive under Reg 1.469-5T(a)(5))

Personal Service Corporations

• Passive loss limitations apply in full to all PSCs, including those that are closely held. A passive loss cannot offset PSC corporate income nor can it create an NOL. A passive loss is any rental loss, or a loss from a business in which the 50%+ shareholder does not materially participate. To materially participate, one or more shareholders owning more than 50% of the stock must meet one of the 7 tests in Reg. 1.469-5T(a). Passive losses are not deductible in the absence of passive income. A passive loss cannot create an NOL. There is no $25,000 offset for rental real estate as a corporation is not a natural person.

Closely Held Corps – Non-PCS

• Closely held = more than 50% of the stock is owned by 5 or fewer shareholders during the last half of the year. Passive losses can offset corporate income, but not portfolio income. A passive loss cannot create an NOL. There is no $25,000 offset for rental real estate as a corporation is not a natural person.

• Material participation in 1065/1120S owned by the corporation requires:

• Shareholders owing more than 50% meet one of the 7 tests in Reg. 1.469-5T(a) OR

• If for entire 12 months:

• (1) A full-time employee of the corporation spends all his time managing the activity AND

• (2) Corp has 3 or more non-owner employees performing services for the business AND

• (3) Corp's expenses exceed 15% of gross income, excluding interest, taxes and depreciation.

Credits

• Credits from a passive activity generally may not be deducted in the absence of passive income. Passive activity credits are deductible only to the tax equivalent of passive income.

• However, credits generated by rental activities (examples: low income housing and rehabilitation credits) are deductible to the extent of the tax equivalent of $25,000 offset (max $9,900 depending on the year). Notes: (1) When modified AGI exceeds $250,000, no rehabilitation credit is allowed. (2) A real estate professional may deduct the LIH or rehabilitation credit in full, but only if he materially participated in the rental activity.

Credits

• A passive activity is generally any rental activity; or any business in which TP did not materially participate.

• On disposition, passive activity credits may not be deducted. Instead, IRC 469(j)(9) provides the taxpayer may elect to increase the basis of the disposed property by any unused credits by completing Form 8582CR Part VI.

Credits

• What credits are subject to the passive activity limitations?• Virtually all credits from a passive activity are limited by the passive activity

rules: low income housing credit, rehabilitation credit, investment credit, welfare-to-work credit, credit for alcohol used as fuel, credit for increasing research activities, enhanced oil recovery credit, alternative fuel vehicle refueling property credit, hurricane Katrina employee retention credit, general credits from electing large partnerships and most other credits. See Instructions for Form 8582-CR for a list of the credits.

• Exceptions (not limited by passive activity rules)• Foreign tax credit

• New markets tax credit

Vacation Homes

• If either of the following apply, the activity falls outside the rental definition, and gets no $25,000 offset. TP must prove that he materially participated before losses are deductible if:

• Average customer use is 7 days or less for the year or

• Average customer use is 30 days or less and significant personal services are provided (maid)

• If TP does not materially participate, losses are not deductible in the absence of passive income.

Dispositions - Losses

• Basic tax law for dispositions• All current and suspended carryovers passive losses are deductible in full

when all of the following are met:

• TP no longer has any ownership of the activity in any form or any entity, or in any amount.

• The activity has been sold or otherwise disposed of to an unrelated party.

• All gain or loss is both realized and recognized.


• Are there any other rules?• Death: Losses are deductible only to the extent they exceed the step-up in

basis (generally FMV) in the hands of the beneficiary. Often the step-up completely absorbs PALS.

• Gift of a passive activity: Losses are added to the donee’s basis. Not deductible.

• Distribution of a passive activity out of a trust or estate: Losses are added to basis just before distribution. They are not deductible by the trust or estate.

• Installment sales: Losses are deductible in ratio to gain reported.


• Dispositions where losses are not triggered (losses remain on Form 8582 – not deductible)• § 1031 Like-kind exchange.

• Conversion to personal use.

• Transfer to a corporation, partnership or LLC in which TP has an ownership interest

• Transfer to a bankrupt estate IRC 1398(f)(1), 1.1398-1(c), 1.1398-1(d)(1)

• Transfer due to divorce (treated as gift-IRC 469(j)(6) & 1041(b)).

• Gift to anyone or charitable contribution to a church

• Abandonment, if TP retains title to property, or transactions are not closed and completed.

Dispositions - Gains

• Basic tax law for gain on sale to be used as passive income on Form 8582?• Passive income triggers deductibility of any kind of passive loss. Gain on sale

generally is passive income IF activity is a passive activity in the year sold. Reg. 1.469-2T(c)(2). Distributions-see Revenue Ruling 95-5.

• But gain is passive and goes on F8582 only if it is more than current and carryover losses from property sold.


• What are some gains which are not passive income, i.e. they do not go on Form 8582?• Building or property simply held for investment IRC 469(e)(1)(A)(ii)(II), , Reg. 1.469-1T(e)(3)(ii)(D)• Covenant not to compete Reg. 1.469-2(c)(7)(iv)• TP does nothing currently but materially participated in prior years Reg. 1.469-5T(a)(5) & (6) • Gain on sale of land held for investment IRC 469(e)(1)(A)(ii) • Gain on sale of leased land Reg. 1.469-2T(f)(3) • Gain on sale of stocks, bonds or other portfolio income IRC 469(e)(1)(A)(ii) • Gain on property leased to a business where TP works (self-rented property) Reg. 1.469-2(f)(6)• Gain if gross rents are less than 2% of unadjusted basis or FMV Reg. 1.469-1T(e)(3)(vi) • Property sold, but not rented in year of sale, i.e. not leased during year Reg. 1.469-2T(c)(2)(i)(A)(iii)• Gain on any activity if it is not a passive activity in the year sold Reg. 1.469-2T(c)(2)(i)(A)(iii) • Gain on sale which is less than current and carryover losses from the activity Reg. 1.469-1T(f)(2)(B) • Gain on sale of property not used in a passive activity in the year sold Reg. 1.469-2T(c)(2)(i)• Gain on sale of self-developed rental property if rented less than 12 months Reg. 1.469-2T(f)(5)• Any property to which the 14 day personal use of § 280A applies If rented at less than fair rental value, those

days are counted as personal use days IRC 469(j)(10), IRC 280A(d)(2)(C)


• Computation• First, net the gain on sale, current year income/loss, and any carryover losses from

the activity. If there is an overall net gain, all income, including gain on sale of property (and recapture) generally goes on Form 8582, as do the current and suspended losses. All income and losses are also reported on the appropriate schedules, typically Schedule E and Form 4797. Losses are fully deductible.

• If there is an overall net loss, none of the losses go on Form 8582, but are reported on the appropriate schedules, if answer to all the following is yes:

• Is there an entire disposition of the activity?• Is all gain or loss (including all expenses) realized and recognized?• Is sale or other disposition to an unrelated party?• If answer is NO, losses remain on Form 8582 - deductible only to extent of passive

income.

Equipment Leasing

• Basic tax law for equipment leasing• Equipment leasing losses are automatically passive, whether or not TP materially

participated! That means they are not deductible unless there is passive income. Only if the activity falls outside the rental definition does material participation become important. See page 15 for the tests for material participation.

• What are the exceptions to the rental definition?• Average customer use is 7 days or less. If lessee (renter) has a recurring right to use property,

lease period is not 7 days or less, but the entire year, i.e. 365 days, or more.• Average customer use is 30 days or less and significant personal services are provided• Extraordinary personal services are provided in connection with property Ex: hospital• Rental is incidental to a non-rental activity. Rents are less than 2% of adjusted basis or FMV. • Property is available during defined business hours for nonexclusive use by customers.• Property is provided (contributed) to a partnership or S corporation. If property is leased

(instead of contributed to a 1065 or 1120S, this exception doe not apply.

Documents

Is that Deductible? A Look at Commonly Asked Business