They reported as income - and SMC deducted as an expense - compensation paid to them for real estate management services for 19. The Hillmans did not materially participate in any other operations SMC conducted, such as recreational services, medical insurance plan underwriting, credit and collection services, and a maintenance-training academy. The Hillmans materially participated in SMC's real estate management activity in excess of 500 hours. SMC engaged in a real estate management activity that the Hillmans treated as a separate activity not aggregated with SMC's other activities.
They did, however, participate in SMC's activities by performing management services that SMC had contracted for the partnerships. The general partner of each either was the Hillmans or an upper-tier partnership or S corporation in which they owned an interest.ĭuring the 19 tax years, the Hillmans did not participate in partnership activities.
The Hillmans owned either direct or indirect interests in each partnership. SMC was classified as an S corporation for federal income tax purposes and it provided real estate management services to about 90 pass-through entities, including joint ventures, limited partnerships, and S corporations that were involved in real estate rental activities (the partnerships). During 1994, they owned 94.3 percent of SMC's stock. Tax Court ruled earlier this year that under certain conditions, deductions incurred as part of a passive activity could be used to offset income from nonpassive activities.ĭuring 1993, David and Suzanne Hillman owned 100 percent of Southern Management Corp.'s stock.
Define passive income code#
In general, Internal Revenue Code Section 469 applies to individuals (including partners and S corporation shareholders), trusts, estates, and personal-service corporations. However, as with many too-good-to-be-true tax schemes, Congress found this practice to be abusive.Īs part of the Tax Reform Act of 1986, Congress enacted the infamous passive-activity rules that effectively disallow taxpayers from sheltering nonpassive, or active, income with losses generated from passive activities. Effectively, taxpayers could buy an interest in real estate and shelter their ordinary income with losses passed through to them. The ability to generate losses was such an advantage that a whole cottage industry sprang up around the creation and exploitation of real estate partnerships during the early 1980s. From a purely tax perspective, depreciable real estate historically provides a positive cash flow while creating noncash or “paper” losses primarily through depreciation deductions in the early years of ownership that can shelter income from non-real estate activities. Taxpayers often consider depreciable real estate a viable investment vehicle because of its potential for capital appreciation and cash flow and its inherent qualities as a tax shelter. Tax issues IRS Ruling on Passive Activity May Offer Tax Break Possibilitiesīy Steven M.
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