The Passive Loss Rules

The law provides that to be “materially participating,” a taxpayer must be involved in operations with respect to the property on a basis that is “regular, continuous and substantial.” You and your spouse will be treated as one taxpayer for purposes of determining whether the material participation requirement has been met. It does not matter whether your spouse owns an interest in the property, or whether you file joint or separate tax returns. The IRS regulations provide that you will be considered to be materially participating in the operation of your timber activity if you meet at least one of the following tests:

(1) You and your spouse participate in the activity for more than 500 hours during the tax year.

(2) You and your spouse’s personal participation in the activity constitutes substantially all of the participation (including that of all other individuals) for the tax year.

(3) You and your spouse participate in the activity for more than 100 hours during the tax year and no other individual participates more.

(4) You and your spouse’s aggregate participation in all of your “significant participation activities,” including your timber activity, exceeds 500 hours during the tax year. An activity is a “significant participation activity” if it is a trade or business in which you participate for more than 100 hours during the tax year. Thus, you could qualify under this test even if another individual who co-owns forest property with you participates in its operation more than you do during the tax year in question.

(5) You and your spouse materially participated in the activity for any of 5 of the preceding 10 tax years.

(6) All of the facts and circumstances of the situation indicate that you and your spouse participated in the activity on a regular, continuous, and substantial basis during the tax year.

The specific rules to be followed in applying this test have not been issued by the IRS as of this writing; however, the agency uses the following general principles as guides. The first is that your management of the timber activity is not taken into account if a paid manager participates in its management or if the management services that you perform are exceeded by those performed by any other individual. Second, if you do not participate in the timber activity for more than 100 hours during a tax year, you cannot satisfy the facts-and-circumstances test for the year.

Formal recordkeeping is not required to prove the number of hours devoted to operation of the timber activity. The taxpayer is allowed to document the number of hours by any reasonable means, including—but not limited to—appointment books, calendars, and narrative summaries.


Source: Dr. John L. Greene, USDA Forest Service, Southern Research Station, 9/20/11