Material Participation

In general, any work you do in connection with an activity in which you own an interest when you perform the work is treated as participation in the activity. Any reasonable method can be used to prove your participation in an activity for the year. You can show the services you performed and the approximate number of hours spent by using an appointment book, calendar, or narrative summary. Work you do in connection with an activity is not treated as participation in the activity if:

The work is not the type of work that is customarily done by the owner of that activity.

One of your main reasons for doing the work is to avoid the disallowance of any loss or credit from the activity under the passive activity rules.

Investor - Work you do in your capacity as an investor in an activity is not treated as participation unless you are directly involved in the day-to-day management or operations of the activity. Work normally done as an investor includes:

  1. Studying and reviewing financial statements or reports on operations of the activity.
  2. Preparing or compiling summaries or analyses of the finances or operations of the activity for your own use.
  3. Monitoring the finances or operations of the activity in a non-managerial capacity.

Spouses - Spouses are treated as one taxpayer for purposes of the passive loss rules. If you are married for the tax year, your participation in an activity includes your spouses participation. The hours of participation in an activity by both spouses are combined in applying the test for material participation to each spouse. This applies even if your spouse did not own any interest in the activity and your spouse do not file a joint return for the year.

Surviving spouses - In certain circumstances surviving spouses of retired or disabled persons may not be subject to the material participation tests. If the timber ownership qualifies as a farm business under section 2032A of the Internal Revenue Code, The surviving spouse need only satisfy an "active management" test. This test does not require that a specified number of hours be worked, nor does it impose restrictions on participation by others. The surviving spouse need only be involved in making major management decisions and not day-today operating decisions.

Limited Partnerships - If you owned an activity as a limited partner, you generally did not materially participate in the activity. However, you did materially participate in the activity if you materially participated for the tax year under Test (1), (5), (6).

C-Corporation - A closely held corporation or a personal service corporation subject to the passive loss rules is treated as materially participating in an activity only if one of the following conditions is met:

  1. One or more shareholders holding more than 50% by value of the outstanding stock of the corporation materially participates in the activity.
  2. If a closely held corporation, certain "qualifying business" requirements under the "at risk rules" are met. This generally means an active business

Rental Activity - Any rental activity, whether or not the taxpayer materially participates, is classified as a passive activity. "Rental activity" is defined as any activity where payments are principally for the use of tangible property, rather than for performance of substantial services. This includes long-term timber and timberland leases. It does not include cutting contracts.

Material Participation Test

Material participation is year-round active involvement in the operations of an activity on a regular, continuous, and substantial basis. You are considered to be materially participating in a trade or business activity for a tax year if you satisfy one of the following tests.

  1. You participated in the activity for more than 500 hours during the year. It does not matter how much time others, such as consultants or workers hired by you participate in the activity.
  2. Your participation is substantially all of the participation in the activity of all individuals for the tax year, including the participation of individuals who did not own any interest in the activity.
  3. You participated in the activity for more than 100 hours during the tax year, and you participated as least as much as any other individual (including individuals who did not own any interest in the activity) for the year.
  4. The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you did not materially participate under any of the material participation tests, other than this test.
  5. You materially participated in the activity for any 5 (whether or not consecutive) of the 10 preceding tax years. When determining whether you materially participated in tax years beginning before 1987 (other than a tax year of a partnership, S corporation, estate, or trust ending after 1986), you materially participated only if you participated for more than 500 hours during the tax year.
  6. You materially participated in an activity for the year if the activity is a "personal service activity" and you materially participated in it for any three taxable years preceding the taxable year. You are considered to have materially participated in the activity in any year before January 1, 1987 only if you participated for more than 500 hours during such year. Personal services activities do not include timber growing
  7. You materially participated in an activity for the year if based on all the facts and circumstances you participated in the activity on a regular, continuous, and substantial basis. You cant meet the facts and circumstances test unless you participated for more than 100 hours during the year.

Note: Satisfying participation requirements under any other provision, such as, those under the "special use valuation" (section 2032A), or self-employment criteria don't apply.