Participation is defined as any work a taxpayer does in connection with an activity in which he owns an interest. However, to be material the taxpayer’s participation must be on a regular, continuous, and substantial basis. For purposes of determining a taxpayer’s participation, a spouse’s activities will be attributed to the taxpayer.
The regulations under §1.469-5T(a) delineate seven tests to determine whether a taxpayer is involved in the operations of an activity on a regular, continuous and substantial basis. Six of those tests are applicable to rental activities. If a taxpayer meets at least one of the following six tests, he or she is treated as materially participating in the rental activity during the tax year.
- The five-of-ten-preceding-years test. A taxpayer is treated as materially participating in a rental activity for the current tax year if the taxpayer materially participated in the rental activity for any five tax years, which do not need to be consecutive, during the 10 tax years that immediately precede the current tax year.
- The substantially all test. A taxpayer whose participation in a rental activity for the tax year constitutes substantially all of the participation in the rental activity by all individuals for the year, including individuals who are not owners of interests in the rental activity, is treated as materially participating in the rental activity.
- The not-less-than-others test. A taxpayer who participates in a rental activity for more than 100 hours during the tax year and whose participation in the rental activity is not less than the participation in the rental activity of any other individual for the year, including individuals who are not owners of interests in the rental activity, is treated as materially participating in the rental activity.
- The 500-hour test. A taxpayer who participates in a rental activity for more than 500 hours during the year is treated as materially participating in the rental activity.
- Significant participation activities test. A taxpayer is treated as materially participating in a rental activity if the rental activity is a significant participation rental activity for that taxpayer for the tax year, and his or her aggregate participation in all significant participation activities exceeds 500 hours for the year. A significant participation activity is a trade or business activity in which the taxpayer participates for more than 100 hours during the tax year, but does not otherwise materially participate within the meaning of any other five tests applicable to rental real estate.
- Facts and circumstances test. If a taxpayer does not satisfy any of the other material participation tests, he or she can be considered to materially participate in an rental activity for the tax year if, based on all of the facts and circumstances, the taxpayer participates in the rental activity on a regular, continuous and substantial basis for such tax year. For this test to be satisfied, however, the taxpayer must participate in the rental activity for more than 100 hours during the tax year.
Despite the above, safe harbor provisions exist when warranted by the facts and circumstances. Under these provisions taxpayers’ are automatically treated as materially participating if a minimum number of hours have been spent in prior years. For instance, if a taxpayer was a retired farmer he or she will be treated as materially participating in farming activity if there was material participation for 5 or more of the 8 years before retirement.
