passive losses and "material participation in an LLC


J

JGE

Last year, I got involved in an LLC that did a small solar
installation. In addition to the various tax credits, it was our
understanding that we would be able to deduct the losses from our
income. The losses, I believe, are from depreciating our capital in
the thing (the money we chipped in to build it), but I think the
details of that don't matter here - what's important is that there's a
negative number on Line 1 (of our K-1 Form 1065).

For 2011, we realized that we hadn't "materially participated" in the
thing, so the loss would be considered "passive", and (absent any
offsetting passive gains) could only be carried forward, to be taken
when the LLC is dissolved in about 5 years. So we changed it so
we're all listed as "general partner or LLC member manager" instead of
"limited partner or other LLC member". This was supposedly going to
allow us to take the loss (against ordinary income) each year. But
it looks to me like all this has done is allow us to use a more
inclusive set of "material participation" tests (7 of them, instead of
3) as described in:

http://www.bizactions.com/showopp.cfm/spid/2296/art/1664/ind/US/

Even so, they all require numbers of hours of commitment that most of
us can't possibly meet, but #7 "you pass if consideration of relevant
facts and circumstances dictate that you materially participate in the
activity on a regular, continuous and substantial basis" looks like it
MIGHT be applicable.

So I'm wondering if the change on the Line G, to "general partner or
LLC member manager" allows us to say we meet this test. Also, Line
I1, "What type of entity is this partner ?" has been changed to
"individual active", so maybe that makes a difference.

You might think that whoever prepares our K-1 would be helping with
this. But they are fellow LLC members, doing it for free on a
voluntary basis, are extremely busy right now as professional
accountants, and simply can't be bothered advising on this right now.

Thanks !
 
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R

removeps-groups

For 2011, we realized that we hadn't "materially participated" in the
thing, so the loss would be considered "passive", and (absent any
offsetting passive gains) could only be carried forward, to be taken
when the LLC is dissolved in about 5 years. So we changed it so
we're all listed as "general partner or LLC member manager" instead of
"limited partner or other LLC member". This was supposedly going to
allow us to take the loss (against ordinary income) each year. But
it looks to me like all this has done is allow us to use a more
inclusive set of "material participation" tests (7 of them, instead of
By changing to a general partner you expose yourself to greater liability. You should not do it just for tax reasons.
http://www.bizactions.com/showopp.cfm/spid/2296/art/1664/ind/US/

Even so, they all require numbers of hours of commitment that most of
us can't possibly meet, but #7 "you pass if consideration of relevant
facts and circumstances dictate that you materially participate in the
activity on a regular, continuous and substantial basis" looks like it
MIGHT be applicable.
The hours requirement don't always make sense. For example they say if you participated more than 500 hours a year. That's about 40 hours a week, a full time job. But if you started the LLC in December and have a calendar year for the LLC, then there's no way you could have worked 500 hours in that one month. 40 hours is more like it.

Also, if the LLC didn't operate much (it was just a part time thing), then I would imagine that the 500 hour limit would be reduced in proportion. So if the LLC operated only one day a week, instead of 5, then it seems logical that the number of hours is reduced to 100 per year.

You might think that whoever prepares our K-1 would be helping with
this. But they are fellow LLC members, doing it for free on a
voluntary basis, are extremely busy right now as professional
accountants, and simply can't be bothered advising on this right now.
Maybe you can file an extension for the LLC and your own 1040's. Still estimate your tax due and file 4868. I have no idea what the answer is.
 
S

Stuart A. Bronstein

removeps-groups@yahoo.com said:
JGE wrote:

The hours requirement don't always make sense. For example they
say if you participated more than 500 hours a year. That's
about 40 hours a week, a full time job.
I'm sorry, but there are about 2000 work hours in a year. So 500
hours is about 10 hours per week.
 
R

removeps-groups

I'm sorry, but there are about 2000 work hours in a year. So 500
hours is about 10 hours per week.
Oops. I did 500/12 and forgot to divide by 4 :).
 
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J

JGE

Also, if the LLC didn't operate much (it was just a part time thing), then I would imagine that the 500 hour limit would be reduced in proportion.  So if the LLC operated only one day a week, instead of 5, then it seems logical that the number of hours is reduced to 100 per year.
This is immaterial really, there's no way any of us work 100 hours or
500 hours, or whatever.
Maybe you can file an extension for the LLC and your own 1040's.  Still estimate your tax due and file 4868.  I have no idea what the answer is.
Oh yeah, I intend to do that - always do, for purposing of taking
maximum advantage of my Roth conversions in the 15% bracket. But i
like to come as close as I can by the time I file extension, plus
trying to help out other members who don't do extensions.
 

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