Tests for determining material participation
Tests for Determining Material Participation
Material participation occurs when the taxpayer's involvement in the trade or business (or rental real estate activity for real estate professionals as discussed in Key Issue 16H) is regular, continuous, and substantial [IRC Sec. 469(h)(1)]. Reg. 1.469-5 and Temp. Reg. 1.469-5T establish guidelines to determine material participation. Any work an individual performs in an activity in which he or she owns an interest (when the work is done) generally is considered participation. However, not all participation is considered material; see the discussion of “Nonqualifying Participation” later in this key issue. An individual materially participates in an activity if any one of the following tests is met:
1. More Than 500 Hours Test. The taxpayer participates in the activity for more than 500 hours during the year.
2. Substantially All Participation Test. The taxpayer's participation in the activity constitutes substantially all of the participation by all individuals (including nonowners) in the activity for the year.
3. More Than 100 Hours Test. The taxpayer's participation is more than 100 hours during the year, and no other individual (including nonowners) participates more hours than the taxpayer. (See Example 16B-1.)
4. Significant Participation Activity (SPA) Test. The activity is a significant participation activity in which the taxpayer participates for more than 100 hours during the year and the taxpayer's annual participation in all significant participation activities is more than 500 hours. [A significant participation activity is generally a trade or business activity (other than a rental activity) that the taxpayer participates in for more than 100 hours during the year but does not materially participate (under any of the material participation tests other than this test).] (See Example 16B-3.)
5. Prior-year Material Participation Test. The taxpayer materially participated in the activity for any five tax years (whether or not consecutive) during the 10 immediately preceding tax years. (See Example 16B-2.)
6. Personal Service Activity Test. For a personal service activity, the taxpayer materially participated for any three tax years (whether or not consecutive) preceding the current tax year. (Personal service includes the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital is not a material income-producing factor.)
7. Facts and Circumstance Test. Based on all the facts and circumstances, the taxpayer participates on a regular, continuous, and substantial basis during the year [Temp. Reg. 1.469-5T(a)(7)]. Future regulations are to provide further guidance for this test. However, temporary regulations indicate that if an individual participates in an activity for 100 hours or less during the year, this “facts and circumstances” test is not available. Participating in the management of an activity is not considered for this test if (a) any person (other than the taxpayer) received compensation for performing services in the management of the activity, or (b) any individual spent more hours during the tax year performing management services than the taxpayer (whether or not the individual was compensated for the management services).