Another Groupings Question

Technical topics regarding tax preparation.
#1
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I have an individual taxpayer where they receive multiple partnership k-1s related to various business activities. Many of these business activities relate to one another e.g. Taxpayer gets two k-1s from related businesses, one k-1 is for a small direct ownership in the entity reporting the business activity, the other k-1 comes from a separate partnership (management company) in which the taxpayer materially participates and receives a GP. The management company manages the business's activities and receives fees related to the services.

In prior years the previous preparer has not filed any grouping elections but has treated both k-1s as nonpassive income. I am sure the previous preparer did not file a grouping election, I have a copy of the originally filed return.

Would it be prudent to file a grouping election on the individual's subsequent tax return for these related entities? e.g. if the individual taxpayer has three similar business dealings, would it make sense to file three grouping elections on the subsequent tax return?
 

#2
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Bump -- I appreciate any and all responses.
 

#3
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A few points for starters:

First, disclosing groupings is somewhat new. The rules came into being about 10 years ago. So, you might have someone that had multiple activities prior to the start-date of these rules wherein certain activities were grouped. Those pre-existing groupings don’t have to be disclosed on subsequent returns. Not sure if your guy’s “activities” pre-date the disclosure rules.

Second, one thing your comments get at is the idea of an activity…and what exactly is the definition of an activity.
 

#4
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Not sure if your guy’s “activities” pre-date the disclosure rules.

They do not. They're all new within the last 4 years or so.
Second, one thing your comments get at is the idea of an activity…and what exactly is the definition of an activity.

The business k-1s have multiple activities disclosed via activity schedules on the k-1s. The management entities do not contain activity schedules, which I suspect is due to only one activity being present (the management of the business).

My concern is that the IRS wouldn't treat the TP's activities as grouped under 469 unless the groupings were disclosed; the risk being that the IRS would ungroup the activities and evaluate them separately for the material participation rules. If the TP wasn't involved in the core businesses but was materially participating in the larger management of the activities, my thought is there might be risk the IRS would treat the core business dealings as passive (as the TP is only a passive investor in the core business entity).
 

#5
Andrew  
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What benefit will you get from grouping? Do you have basis in each of the partnerships? What type of partner is your client on the K-1?

"The grouping decision should generally have been made in 1994 when Regs. Sec. 1.469-4 was finalized or, if after that date, at the time the activity was first reflected on a return. Taxpayers must comply with IRS disclosure requirements regarding both their original groupings and the addition or disposition of specific activities within those groupings in ensuing tax years."
 

#6
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What benefit will you get from grouping? Do you have basis in each of the partnerships? What type of partner is your client on the K-1?

The benefit is treating the core business k-1s as nonpassive vs. passive (there are losses at that level). There is plenty of basis. The partner is a limited partner in the core business and a managing partner in the management entity.

I'm not sure where your quote is from. The previous preparer has been treating the activities as grouped despite not disclosing a grouping election on the original or on any of the previous returns filed.

What is the harm in disclosing existing groupings on a subsequent return?
 

#7
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My concern is that the IRS wouldn't treat the TP's activities as grouped under 469 unless the groupings were disclosed


Ok. You’ve provided a bit more clarity, although things still aren’t crystal clear, as to the totality of things. For example, how many K1’s are there altogether? And how many activities are on each K1? Do any of the separate activities listed on each K1 overlap with the same activity/activities on other K1’s? Etc., etc. To be complete here, you’d say something like: K1 #1, Activities A, B and C. K1 #2, Activities B, D and E. Then we know what specificially we’re dealing with. And then you’d tell us how things were reported/presented on the 1040.

In any case…When it comes to tax elections, there is this concept of “clearly notifiying” or “clearly communicating” the election to the IRS. (Sometimes you see the word “overt” thrown in there). This communication/notification can be accomplished without filing a formal election in some cases. The key is that the tax return presentation makes it clear, with no other possibility, that the election has been made.

Let me give you an example: A real estate professional: He has 5 rentals, separately listed on Schedule E, Page 1. Each shows a loss. The taxpayer has no passive income. The taxpayer deducts 100% of the loss for each of the 5 rentals. None of those losses show up on Form 8582. Assume the taxpayer failed to make a formal Aggregation Election with his 1040. But is he deemed to have made an Aggregation Election based on how he reported things? No, he is not deemed to have made an election. That’s because, due to his reporting, it’s possible that he’s asserting that he was non-passive in each rental on a separate basis. Although the way he reported things is consistent with an Aggregation Election, it’s also consistent with non-passive treatment, separately, for each rental. Thus, the way he reported things isn’t consistent, exclusively, with the Aggretation Election.

Now, parlay this idea into your situation and let us know what you think.
 

#8
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Permanently-Diff wrote:The partner is a limited partner in the core business and a managing partner in the management entity.

Reg. 1.469-4(d)(3) says that you can’t group a limited partnership interest with any other activity unless the other activity is engaged in the same type of business and the grouping constitutes an appropriate economic unit.
 

#9
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Reg. 1.469-4(d)(3) says that you can’t group a limited partnership interest with any other activity unless the other activity is engaged in the same type of business and the grouping constitutes an appropriate economic unit.

Reg 1.469-4(d)(3)
Except as provided in this paragraph, a taxpayer that owns an interest, as a limited partner or a limited entrepreneur (as defined in section 464(e)(2)), in an activity described in section 465(c)(1), may not group that activity with any other activity.

The Taxpayer does not own an interest in a limited Section 465(c)(1) activity so this won't apply.
Then we know what specifically we’re dealing with. And then you’d tell us how things were reported/presented on the 1040.

I could have been more clear. I'm trying to be as brief as possible.
No, he is not deemed to have made an election. That’s because, due to his reporting, it’s possible that he’s asserting that he was non-passive in each rental on a separate basis. Although the way he reported things is consistent with an Aggregation Election, it’s also consistent with non-passive treatment, separately, for each rental.

This is my concern. Without a clear notification (overt disclosure), it'd be easy for the IRS to argue your exact scenario above when it comes to groupings a Taxpayer silently makes -- the argument being that without the overt disclosure, the TP is taking the position that s/he materially participates in any/all activities treated as non-passive on his/her return (on a separate basis).
 

#10
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This is my concern. Without a clear notification (overt disclosure), it'd be easy for the IRS to argue your exact scenario above when it comes to groupings a Taxpayer silently makes -- the argument being that without the overt disclosure, the TP is taking the position that s/he materially participates in any/all activities treated as non-passive on his/her return (on a separate basis).


In Post #7, by the way, those facts were taken straight from the Kosonen case. In that case, the activities were separately reported on the 1040. And then each loss was separately deducted. In your case, the activities have not been separately reported in the past. That might be a distinguishing factor. Maybe. You see, when you present separately, and then deduct separately, a question arises: Why the deduction? Because of Aggregation or because non-passive in each activity presented? I agree. We don’t know, absent a formal Aggregation election.

But in your case, we never engaged in separate 1040 reporting. Thus, the IRS would have to argue that the taxpayer, behind the scenes, on an Excel spreadsheet, added up the numbers for the various K1 activities into a single total and then presented 1 total on Schedule E, Page 2. A clear admission that he’s non-passive in each activity. But we’d say, “No. A review of the tax return reveals one loss number with respect to ABC, LLC. That’s a clear admission that we grouped.”

It just seems to me that the IRS might not have a slam dunk with it’s argument. That’s all I’m saying.

(Also, I wonder…if, in your case, we had one K1 activity with a loss, and one K1 activity with a profit, how was that presented – as 1 net number or 2 separate numbers? If two separate numbers, that would be an indication that the preparer treated the activities as separate).

Don’t get me wrong. I understand your point. And it’s a fair one. I simply think the IRS might have a harder time arguing - when it comes to K1 activities that were lumped together and presented as 1 number on Schedule E, Page 2 – that grouping had not taken place. There is no case law that I know of here.

Part of the issue is how things get presented on a 1040 and what those specific requirements are. With Schedule E, Page 1, for example, those rules require a separate column for each property. Does this mean each property is a separate activity for Sec 469 purposes? No, it does not. But our software will likely run it out that way. When it comes to K1 entries, there are no detailed reporting requirements for “activities.” The instructions say to put the name of the entity and the EIN, that’s it. Despite this Rev Proc, the actual reporting presentation for K1 stuff is entirely opaque. This is why the Rev Proc came out in the first place. Obviously, it didn’t change how we must present things. But it did create this one thing – this disclosure requirement – that the IRS believes is the only thing that clearly manifests one’s decision to group. I’m just giving a little pushback here on that notion, when it comes to K1 activities.

Further, we are dealing with a Rev Proc here, not a statutory election, like with 469(c)(7).

In short, I recognize the validity of your argument. But I’m also saying that if push comes to shove, there’s a few defenses you can put forth.
 

#11
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My concern lies with how the activities were reported on prior year tax returns.

Here's a refresher on a simple but similar scenario to this Taxpayer:

K-1 #1 -- has one activity A -- managing partner in LLC, materially participates, K1 shows box one income and GPs.

K-1 #2 -- has three activities B/C/D -- limited partner in LLC, doesn't materially participate in any activity, box 1 shows losses in past and continues to show losses, which I'm speculating is due to bonus depreciation, TP has plenty of basis

Prior tax returns -- return showed two numbers on Schedule E pg2, K-1 #1 with non-passive income and K-1 #2 with non-passive loss.

Activities B/C/D are grouped together, that much is certain. But are they grouped with activity A? I would think there's argument to say no. If that's the case, would it be prudent to include a grouping election in the current year return?

Just had another thought, if the IRS doesn't respect the original grouping because they weren't disclosed, why would they respect a late grouping election/disclosure?
 

#12
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But are they grouped with activity A?


I assume K1 #1 is the Management entity. Now we kind of get into a different question: Should his time spent on Activity A (also) be counted towards his time spent on Activities B, C and D? Now you’re getting at the concept of Participation. What do the Regs say about that???
 

#13
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Should his time spent on Activity A (also) be counted towards his time spent on Activities B, C and D?

This Taxpayer is spread thin time-wise. He materially participates in A, but not in activities B, C, D on a separate basis -- or possibly he materially participates in A and B, but not C and D, or A and C, but not B and D, etc. Figuring this Taxpayer's individual participation in each separate activity would be an arduous task due to the volume of activities. This task would be simpler if the activities were grouped based on appropriate economic units.

Maybe I'm being too lazy.
 

#14
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He materially participates in A, but not in activities B, C, D on a separate basis -- or possibly he materially participates in A and B, but not C and D, or A and C, but not B and D, etc.


What exactly is the situation here? In your Post #11, is K1 #1 the management entity? And is K1 #2 various operating businesses, all of which are managed by K1 #1?
 

#15
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K-1 #1 -- has one activity A -- managing partner in LLC, materially participates, K1 shows box one income and GPs.

K-1 #2 -- has three activities B/C/D -- limited partner in LLC, doesn't materially participate in any activity, box 1 shows losses in past and continues to show losses, which I'm speculating is due to bonus depreciation, TP has plenty of basis

This is the scenario. Activity A is K-1 #1. Activities B, C, and D are K-1 #2.
He materially participates in A, but not in activities B, C, D on a separate basis -- or possibly he materially participates in A and B, but not C and D, or A and C, but not B and D, etc.

The Taxpayer is materially participating in K-1 #1 (activity A) and not materially participating in K-1 #2 (activities B, C, and D).
 

#16
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This is the scenario. Activity A is K-1 #1. Activities B, C, and D are K-1 #2.


I know that. Either you’re not going to answer my question or you’re saying there is no relationship between these entities/activities/businesses. Go back to Post #4.

Are you, or are you not, saying that the K1 #1 entity manages some or all of the businesses operated by the K1 #2 entity?
 

#17
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I apologize, I'm a little confused.
Are you, or are you not, saying that the K1 #1 entity manages some or all of the businesses operated by the K1 #2 entity?

This is correct. I am saying that. There is a relationship between these four activities (A, B, C, D). A is the managing activity and B/C/D are the operating businesses in which A manages. B/C/D pay a management fee to activity A for management services.
 

#18
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Ok, I found this in the 469 Regs:
(f) Participation.
(1) In general. Except as otherwise provided in this paragraph (f), any work done by an individual (without regard to the capacity in which the individual does the work) in connection with an activity in which the individual owns an interest at the time the work is done shall be treated for purposes of this section as participation of the individual in the activity.


Does your client spend time managing each of B, C and D? Are there other managers, in addition to your client?
 

#19
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Does your client spend time managing each of B, C and D?

That is what concerns me -- I'd rather simplify this analysis by disclosing a grouping election. The Taxpayer is a managing partner in a handful of these groups of entities; and by "groups of entities" I mean they have five businesses they're managing with five groups of k-1s, approximately 30 k-1s in all, with varying activities underneath those k-1s. To drill down and determine participation into each separate activity disclosed on the roughly 25 business k-1s would be arduous, which is why I'm considering disclosing the groupings. There's no way the Taxpayer couldn't hit material participation when the five businesses are grouped appropriately into economic units.
Are there other managers, in addition to your client?

There are other a few other managers involved. There are some day-to-day responsibilities, some financing and equity related activities, acquisitions they're considering, etc etc.
 


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