Limited Partner Actively Participating in a Partnership's Rental Real Estate Income

[Anonymous]

Publications 925 indicates that "Limited Partners aren't treated as actively participating in a partnership's rental real estate activities. This suggests that a limited partner cannot offset ordinary income with losses from a partnership's rental real estate activities. On the other hand, TurboTax Schedule K-1 (for partnerships), Part III, Line 2 has certain boxes which can be checked if one "actively participated in rental reas estate activities". I checked this box to indicate that I do actively participate. Also, I am a Limited Partner and I also checked this box in TurboTax Sch K-1, Part II, Line G. With these two boxes checked, TurboTax is offsetting my ordinary income with losses from my partnership's rental real estate activities. Could you tell me if TurboTax is treating this correctly, and if so why does it seem inconsistent with Publication 925? Thanks, Steve

[tagteam · Accepted solution]

Go with the Publication since it is essentially repeating what is written in Section 469(i)(6(C) of the Code:

Except as provided in regulations, no interest as a limited partner in a limited partnership shall be treated as an interest with respect to which the taxpayer actively participates.

[Anonymous]

Thanks for your response.  I think it's the right answer, even if not the best one from the point of view of the tax liability.

I do have a follow up question.

Could you tell me how I can review the TurboTax Interview questions that I answered, that caused the incorrect boxes to be checked on the TurboTax Sch K-1 form?

It seems like I must have misinterpreted some of the questions, and I'd like to understand why, but when I go through the Interview again, I never get to the point where it asks those questions again.

Thanks for your help,

Steve 

[tagteam]

@Anonymous I cannot seem to get to any question even remotely related to active participation in Step-by-Step. I am, however, able to enter Forms Mode and check the box on the K-1 (which I believe I should not be able to do).

[Anonymous]

Thanks Champ.  I have everything I need.  But I want to pass along to you that I believe the TurboTax Premier Step-by-Step interview has some weaknesses that TurboTax may want to resolve.

First, the step-by-step for Schedule K-1 entries has a series of questions about material participation that are designed to get the correct tax treatment.  These questions can be initiated by selecting the "EasyStep" feature with the step-by-step process. However, I do not believe the questions are entirely clear or complete, causing potential incorrect tax treatment.

Second, after the Schedule K-1 is completed, the step-by-step process does not allow you to go back and review the EasyStep questions and answers.  In effect, you are locked in to your original responses, unless you go to the Forms section and figure out how to make changes to some of the questions.  But, in the Forms mode, TurboTax does not have the definitions (for material participate, actively participate, etc.) that are available in the step-by-step process.

Third, the algorithm I used to determine the proper tax treatment is shown in the 7 steps below.  I believe TurboTax does not fully address the determination of tax treatment for rental income.

Anyway, I figured out everything I needed in order to properly complete the K-1s in TurboTax, and get the correct tax treatment, but I wanted to pass this feedback to you, in case TurboTax wants to improve the step-by-step process.

	Summary of IRS Rules Covering Tax Treatment of LLC Rental Income - Based on Publication 925
1	There are 2 kinds of "passive activities": (i) Trade/Business activities in which you don't materially participate, and (ii) Rental activities, even if you materially participate in them (unless you're a real estate professional).
2	Special $25,000 Allowance Exception - If you actively participate in a passive rental activity, the amount of the passive activity loss that is disallowed is decreased, and therefore you can deduct up to $25,000 of loss activity from your nonpassive income.
3	Active Participation - Active participation is a less stringent standard than material participation.  For example, you may be treated as actively participating if you make management decisions in a significant and bona fide way.
4	Only individuals can actively participate in a rental real estate activities.
5	Limited partners aren't treated as actively participating in a partnership's rental real estate activities.
6	If you are a Real Estate Professional, rental real estate activities in which you materially participated aren't passive activities.
7	Real Estate Professional Defined - Must meet two requirements: (i) more than 50% of your services performed in all trades/businesses were performed in real estate property trades/businesses in which you materially participated.