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Defining "activity" for passive losses.

In May 1989, the Internal Revenue Service issued a complex set of temporary regulations defining "activity" for passive loss purposes. The temporary regulations used a building-block approach, starting with an "undertaking" and then combining these into "activities" and integrated businesses.

In 1989 tax returns, taxpayers disclosed their treatments of rental real estate undertakings and also generally elected to treat combined nonrental undertakings as separate activities for disposition purposes.

But under the three-year sunset clause for temporary regulations, these rules have now expired, applying only to tax years ending on or before May 10,' 1992.

Proposed regulations have replaced the temporary regulations with a "facts and circumstances" approach, treating one or more businesses or rentals as a single activity if they constitute an appropriate economic unit for the measure of gain or loss (proposed regulations 1.469-4, PS-01-89, May 15, 1992).

The proposals are more flexible than the temporary regulations, allowing taxpayers to use any reasonable method to separate or aggregate their activities into appropriate economic units. However, the following factors are given greatest weight: type of business, common control and ownership, geographic location and business interdependence.

In general, a rental activity will not be combined with a trade or business activity unless either is insubstantial in relation to the other.

As in the past, a consistency requirement is imposed once a taxpayer has grouped its activities. However, when claiming suspended losses, a disposition of a substantial part of an activity may be treated as a complete disposition-provided the taxpayer can establish with reasonable certainty the amount of carryover disallowed deductions allocable to that part of the activity.

The proposed regulations are generally effective for tax years ending after May 10, 1992.

Observation: The definition of "activity" has significance for measuring material participation--such as under the 500-hour test--and for identifying an activity for the complete disposition rule allowing use of suspended losses.
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Article Details
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Publication:Journal of Accountancy
Article Type:Brief Article
Date:Aug 1, 1992
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