The passive loss rules apply to activities that involve the conduct of a trade or business and the taxpayer does not materially participate in the activity or in rental activity on a basis which is regular, continuous and substantial. If the passive loss rules apply, deductions (losses) from passive trade or business activities, to the extent the deductions exceed income from all passive activities, may not be deducted against other income (non-passive activity gains). For farmers, the passive loss rules are likely to come into play in situations where the farmer is a passive investor in a separate business venture apart from the farming operation. In that case, the losses from the venture cannot be used to offset the income from the farming operation - unless the farmer can group the activities together as a single economic unit for passive loss purposes. If grouping can be done, the farmer's material participation in the farming activity will count as material participation in the passive business, and the losses will offset the farming income.
Any reasonable method for making the grouping determination can be utilized, but certain factors are given the greatest weight in determining whether activities should be grouped or kept separate - (1) similarities or differences in types of businesses; (2) extent of common control; (3) extent of common ownership; (4) geographic location; and (5) business interdependencies.
The election to group activities is made by filing a statement with the taxpayer's original income tax return for the taxable year.
The following are sample election statements. One is for a grain storage activity and the other is for a hog breeding facility.
Grain storage activities (commonly referred to as "condominium grain storage") are typically owned by an LLC rather than by individual farmers. So the farmer/taxpayer is investing in an LLC that owns the storage facility. This not only provides liability protection for the farmer/investor, but also allows the LLC to depreciate the storage structure and associated equipment and pass that depreciation through to the farmer/investor.
Persons involved in real estate activities may qualify as a "real estate professional" for purposes of the passive loss rules. A person can qualify as a real estate professional if they engage in real estate activities for more than 750 hours and don't spend more time in a non-real estate activity. IRS has taken the position that the 750-hour test must be met for each activity. Thus, the ability to group multiple activities so as to meet the 750-hour test is very important.
In Rev. Proc. 2011-34, 2011-24 I.R.B. 1, IRS says that real estate professionals that have losses from rental activities can make the grouping election on a retroactive basis. Several requirements have to be satisfied to make a retroactive election - the taxpayer must have filed returns that are consistent with single-activity election status for all of the tax years to which the late election is to apply, and the taxpayer must have reasonable cause for making the late election. Procedurally, the election is made by amending the most recently filed return and attaching a statement informing IRS of the grouping election on a retroactive basis in accordance with the Rev. Proc. Once the election is made, the taxpayer will be treated as having made a timely election to treat all interests in rental real estate activities as a single rental real estate activity as of the tax year for which the late election is requested.
The effective date of the Rev. Proc. is Jun 13, 2011 and it applies to all letter ruling requests that are pending with IRS on June 13 and requests for relief after that date.