Material Participation

Personal service corporations and closely held corporations materially or significantly participate in an activity if one or more individuals, each of whom would materially or significantly participate in the activity if the corporation's activity were the individual's activity, directly or indirectly own more than 50% (by value) of the corporation's outstanding stock. For this purpose, an individual's participation in all activities other than activities of the corporation is disregarded.

A closely held corporation also materially participates in an activity if the corporation satisfies the qualifying business requirements of section 465(c) (7)(C) (without regard to section 465(c)(7) (C)(iv) for the excluded business exception from the at-risk limitations).

These requirements are met if:

1. During the entire 12-month period ending on the last day of the tax year, substantially all the services of at least one full-time employee of the corporation were in the active management of the activity;

2. During the same period, substantially all the services of at least three full-time nonowner employees were directly related to the activity; and

3. The deductions attributable to the activity and allowed solely under sections 162 and 404 exceed 15% of the gross income from the activity for the tax year.

Participation. For purposes of the material participation tests listed later, participation generally includes any work the individual did (without regard to the capacity in which the individual did it) in connection with an activity in which the corporation owned an interest at the time the individual did the work.

Work is not treated as participation, however, if the work is not work that an

during the tax year is to realize a gain from its appreciation and the gross rental income is less than 2% of the smaller of the unadjusted basis or the FMV of the property.

Unadjusted basis is the cost of the property without regard to depreciation deductions or any other basis adjustment described in section 1016.

The rental of property is incidental to a trade or business activity if:

a. The corporation owned an interest in the trade or business activity during the tax year,

b. The rental property was mainly used in the trade or business activity during the tax year or during at least 2 of the 5 preceding tax years, and

c. The gross rental income from the property is less than 2% of the smaller of the unadjusted basis or the FMV of the property.

Lodging provided for the employer's convenience to an employee or the employee's spouse or dependents is incidental to the activity or activities in which the employee performs services.

4. The corporation customarily makes the rental property available during defined business hours for nonexclusive use by various customers.

5. The corporation provides property for use in a nonrental activity of a partnership or joint venture in its capacity as an owner of an interest in the partnership or joint venture.

Example. If a partner contributes the use of property to a partnership, none of the partner's distributive share of partnership income is income from a rental activity unless the partnership is engaged in a rental activity.

Also, a partner's gross income attributable to a guaranteed payment under section 707(c) is not income from a rental activity. The determination of whether the property used in the activity is provided in the partner's capacity as an owner of an interest in the partnership is made on the basis of all the facts and circumstances.

Reporting Income, Deductions, Losses, and Credits From Rental Activities If the corporation meets any of the five exceptions listed above, the corporation's rental of the property is not a rental activity. The corporation then must determine:

1. Whether the rental of the property is a trade or business activity (see Trade or Business Activities , later) and, if so,

2. Whether the corporation materially participated in the activity for the tax year.

To report income, deductions, losses, or credits from a trade or business activity in which the corporation did not materially participate, see Trade or business activities without material participation under Reporting Income, Deductions, Losses, and Credits From Trade or Business Activities, later.

If the corporation meets any of the five exceptions and the activity is a trade or business activity in which the corporation materially participated, report any income, deduction, loss, or credit from the activity on the forms or schedules normally used.

If the rental activity did not meet any of the five exceptions, it is generally a passive activity. Special rules apply if the corporation conducted the rental activity through a publicly traded partnership (PTP) or if any of the rules described under Recharacterization of Passive Income , later, apply. See PAL rules for partners in PTPs under Special Instructions for PTPs, later.

If none of the special rules apply, use Worksheets 1 and 2 to determine the amount to enter in Part I of Form 8810 for each passive rental activity. If the corporation has credits from passive rental activities, use Worksheet 5 to figure the amount to enter in Part II of Form 8810. The worksheets are located later in the instructions.