According to the IRS, a trade or business is considered a passive activity unless the taxpayer materially participates. You can claim to have materially participated in the operation of a trade or business activity by meeting one of seven following tests:
1You participated in the activity for more than 500 hours.
2Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who didn’t own any interest in the activity.
3You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who didn’t own any interest in the activity) for the year.
4The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you didn’t materially participate under any of the material participation tests, other than this test. See Significant Participation Passive Activities , under Recharacterization of Passive Income, later.
5You materially participated in the activity (other than by meeting this fifth test) for any 5 (whether or not consecutive) of the 10 immediately preceding tax years.
6The activity is a personal service activity in which you materially participated for any 3 (whether or not consecutive) preceding tax years. An activity is a personal service activity if it involves the performance of personal services in the fields of health (including veterinary services), law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital isn’t a material income-producing factor.
7Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the year.
You didn’t materially participate in the activity under test (7) if you participated in the activity for 100 hours or less during the year. Your participation in managing the activity doesn’t count in determining whether you materially participated under this test if:
Any person other than you received compensation for managing the activity, or
Any individual spent more hours during the tax year managing the activity than you did (regardless of whether the individual was compensated for the management services).
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