U.S. Return of Income for Electing Large Partnerships

Other Activities

The term other activities means activities other than passive loss limitation activities. This is income or expenses connected with property held for investment, i.e., portfolio income. Generally, portfolio income includes all gross income, other than income derived in the ordinary course of a trade or business, that is attributable to interest; dividends; royalties; income from a real estate investment trust, a regulated investment company, a real estate mortgage investment conduit, a common trust fund, a controlled foreign corporation, a qualified electing fund, or a cooperative; income from the disposition of property that produces income of a type defined as portfolio income; and income from the disposition of property held for investment. Portfolio income is reported separately and is reduced by portfolio deductions, allocable investment interest expense, and nonbusiness deductions.

Special Reporting Requirements

General Partners

Passive Activity Reporting Requirements

To allow general partners to correctly apply the passive activity loss and credit rules, any partnership that carries on more than one activity must:

1. Provide an attachment for each activity conducted through the partnership that identifies the type of activity conducted (trade or business, rental real estate, rental activity other than rental real estate, or investment). See Grouping Activities on page 11.
2. On the attachment for each activity, provide a schedule detailing the net income (loss), credits, and all items required to be separately stated under section 772(a) from each trade or business activity, from each rental real estate activity, from each rental activity other than a rental real estate activity, and from investments.
3. Identify the net income (loss) and credits from each oil or gas well drilled or operated under a working interest that any partner (other than a partner whose only interest in the partnership during the year is as a limited partner) holds through the partnership. Further, if any partner had an interest as a general partner in the partnership during less than the entire year, the partnership must identify both the disqualified deductions from each well that the partner must treat as passive activity deductions, and the ratable portion of the gross income from each well that the partner must treat as passive activity gross income.
4. Identify the net income (loss) and the partner's share of partnership interest expense from each activity of renting a dwelling unit that any partner uses for personal purposes during the year for more than the greater of 14 days or 10% of the number of days that the residence is rented at fair rental value.
5. Identify the net income (loss) and the partner's share of partnership interest expense from each activity of trading personal property conducted through the partnership. For this purpose, personal property means property that is actively traded such as stocks, bonds, and other securities. See Temporary Regulations section 1.469-1T(e)(6).
6. For any gain (loss) from the disposition of an interest in an activity or of an interest in property used in an activity (including dispositions before 1987 from which gain is being recognized after 1986):
   1. Identify the activity in which the property was used at the time of disposition.
   2. If the property was used in more than one activity during the 12 months preceding the disposition, identify the activities in which the property was used and the adjusted basis allocated to each activity.
   3. For gains only, if the property was substantially appreciated at the time of the disposition and the applicable holding period specified in Regulations section 1.469-2(c)(2)(iii)(A) was not satisfied, identify the amount of the nonpassive gain and indicate whether the gain is investment income under the provisions of Regulations section 1.469-2(c)(2)(iii)(F).
7. Specify the amount of gross portfolio income, the interest expense properly allocable to portfolio income, and expenses other than interest expense that are clearly and directly allocable to portfolio income.
8. Identify separately any of the following types of payments to partners:
   1. Payments to a partner for services other than in the partner's capacity as a partner under section 707(a).
   2. Guaranteed payments to a partner for services under section 707(c).
   3. Guaranteed payments for use of capital.
   4. If section 736(a)(2) payments are made for unrealized receivables or for goodwill, the amount of the payments and the activities to which the payments are attributable.
   5. If section 736(b) payments are made, the amount of the payments and the activities to which the payments are attributable.
9. Identify the ratable portion of any section 481 adjustment (whether a net positive or a net negative adjustment) allocable to each partnership activity.
10. Identify the amount of gross income from each oil or gas property of the partnership.
11. Identify any gross income from sources that are specifically excluded from passive activity gross income, including:
    1. Income from intangible property if the partner is an individual and the partner's personal efforts significantly contributed to the creation of the property.
    2. Income from state, local, or foreign income tax refunds.
    3. Income from a covenant not to compete (in the case of a partner who is an individual and who contributed the covenant to the partnership).
12. Identify any deductions that are not passive activity deductions.
13. If the partnership makes a full or partial disposition of its interest in another entity, identify the gain (loss) allocable to each activity conducted through the entity, and the gain allocable to a passive activity that would have been recharacterized as nonpassive gain had the partnership disposed of its interest in property used in the activity (because the property was substantially appreciated at the time of the disposition, and the gain represented more than 10% of the partner's total gain from the disposition).
14. Identify the following items from activities that may be subject to the recharacterization rules under Temporary Regulations section 1.469-2T(f) and Regulations section 1.469-2(f):
    1. Net income from an activity of renting substantially nondepreciable property.
    2. The smaller of equity-financed interest income or net passive income from an equity-financed lending activity.
    3. Net rental activity income from property that was developed (by the partner or the partnership), rented, and sold within 12 months after the rental of the property commenced.
    4. Net rental activity income from the rental of property by the partnership to a trade or business activity in which the partner had an interest (either directly or indirectly).
    5. Net royalty income from intangible property if the partner acquired the partner's interest in the partnership after the partnership created the intangible property or performed substantial services, or incurred substantial costs in developing or marketing the intangible property.
15. Identify separately the credits from each activity conducted by or through the partnership.

For more information on passive activities, see Pub. 925, Passive Activity and At-Risk Rules.

Grouping Activities

Generally, one or more trade or business activities or rental activities may be treated as a single activity if the activities make up an appropriate economic unit for the measurement of gain or loss under the passive activity rules. Whether activities make up an appropriate economic unit depends on all the relevant facts and circumstances. The factors given the greatest weight in determining whether activities make up an appropriate economic unit are:

• Similarities and differences in types of trades or businesses.
• The extent of common control.
• The extent of common ownership.
• Geographical location.
• Reliance between or among the activities.

Example. The partnership has a significant ownership interest in a bakery and a movie theater in Baltimore and a bakery and a movie theater in Philadelphia. Depending on the relevant facts and circumstances, there may be more than one reasonable method for grouping the partnership's activities. For instance, the following groupings may or may not be permissible:

• A single activity,
• A movie theater activity and a bakery activity,
• A Baltimore activity and a Philadelphia activity, or
• Four separate activities.

Once the partnership chooses a grouping under these rules, it must continue using that grouping in later tax years unless a material change in the facts and circumstances makes it clearly inappropriate.

The IRS may regroup the partnership's activities if the partnership's grouping fails to reflect one or more appropriate economic units and one of the primary purposes of the grouping is to avoid the passive activity limitations.

Limitation on grouping certain activities. The following activities may not be grouped together:

1. A rental activity with a trade or business activity unless the activities being grouped together make up an appropriate economic unit and
   1. The rental activity is insubstantial relative to the trade or business activity or vice versa or
   2. Each owner of the trade or business activity has the same proportionate ownership interest in the rental activity. If so, the portion of the rental activity involving the rental of property to be used in the trade or business activity may be grouped with the trade or business activity.
2. An activity involving the rental of real property with an activity involving the rental of personal property (except personal property provided in connection with the real property or vice versa).
3. Any activity with another activity in a different type of business and in which the partnership holds an interest as a limited partner or as a limited entrepreneur (as defined in section 464(e)(2)) if that other activity engages in holding, producing, or distributing motion picture films or videotapes; farming; leasing section 1245 property; or exploring for or exploiting oil and gas resources or geothermal deposits.

Activities conducted through other partnerships. Once a partnership determines its activities under these rules, the partnership as a partner may use these rules to group those activities with:

• Each other,
• Activities conducted directly by the partnership, or
• Activities conducted through other partnerships.

A partner may not treat as separate activities those activities grouped together by a partnership.

Tax-Exempt Partners

A tax-exempt partner is subject to tax on its distributive share of partnership income to the extent that the partnership activity is an unrelated business for the partner. Therefore, partnership items must be separately reported to tax-exempt partners to allow them to compute income from an unrelated business.

Publicly Traded Partnerships

For electing large partnerships, the requirement that the passive loss rules be separately applied to each publicly traded partnership continues to apply.

Partnerships Holding Residual Interests in Real Estate Mortgage Investment Conduits (REMICs)

For purposes of the excise tax on partnerships holding residual interests in REMICs, all interests in an electing large partnership are treated as held by disqualified organizations. Therefore, an electing large partnership holding a residual interest in a REMIC is subject to an annual tax equal to 35% of the excess inclusions. The amount that is subject to tax is excluded from partnership income. To report and pay this tax, file Form 8831, Excise Taxes on Excess Inclusions of REMIC Residual Interests.

Partnerships Holding Oil and Gas Properties

Partnerships holding oil and gas properties generally follow the same simplified reporting rules as other electing large partnerships. However, certain partners are treated as disqualified persons, and special rules apply.

Computing depletion. Depletion is generally computed at the partnership level. The 1,000-barrel-per-day-limitation on depletion does not apply. Depletion is also computed without regard to the 65-percent-of-taxable-income limitation and the depletion basis adjustment. The depletion deduction is computed with the assumptions that the partnership is the taxpayer and that it qualifies for the percentage depletion deduction. This deduction is reported to partners (other than disqualified persons) as part of their share of the taxable income (loss) from passive loss limitation activities.

Disqualified persons. Two categories of taxpayers are defined as disqualified persons:

• Certain retailers and refiners who do not qualify for the section 613A percentage depletion deduction. See section 613A(d)(2) and (4).
• Any other person whose average daily production of domestic crude oil and natural gas exceeds 500 barrels for its tax year in which the partnership's tax year ends. See section 776(b) for more details.

A disqualified person must notify the partnership of its status as such.

Reporting to disqualified persons. An electing large partnership reports information related to oil and gas activities to a disqualified person in box 9 of Schedule K-1 (Form 1065-B) providing the same information as required for other partnerships. This information may be provided in an attached statement if additional space is required. However, the simplified rules do apply to a disqualified person's share of items not related to oil and gas activities.

Other reporting requirements. Unlike other partnerships, the election to deduct intangible drilling and development costs (IDCs) is made at the partnership level, and the partnership may passthrough a full deduction of IDCs to its partners who are not disqualified persons. Also, an electing large partnership (and not the partners) makes the section 59(e) election to capitalize and amortize certain specific IDCs for its partners who are not disqualified persons. However, partners who are disqualified persons are permitted to make their own separate section 59(e) election.

A single AMT adjustment (under either corporate or noncorporate rules) is made and reported to partners who are not disqualified persons. This separately reported item is affected by the limitation on the repeal of the tax preference for excess IDCs. For purposes of computing this limitation, the partnership is treated as the taxpayer. Thus, the limitation on repeal of the IDC preference is applied at the partnership level and is based on the cumulative reduction in the partnership's alternative minimum taxable income resulting from repeal of that preference.

Finally, in making partnership-level computations, any item of income, gain, loss, deduction, or credit attributable to a disqualified person is disregarded. For example, in computing the partnership's net income from oil and gas for purposes of determining the IDC preference to be reported to partners as part of the AMT adjustment, disqualified persons' distributive shares of the partnership's net income from oil and gas are not taken into account.

Extraterritorial Income Exclusion

The partnership may exclude extraterritorial income to the extent of qualifying foreign trade income. For details and to figure the amount of the exclusion, see Form 8873, Extraterritorial Income Exclusion, and its separate instructions. The partnership must report the extraterritorial income exclusion on its return as follows:

1. If the partnership met the foreign economic process requirements explained in the Instructions for Form 8873, it may report the exclusion as a non-separately stated item on whichever of the following lines apply to that activity:
   • Form 1065-B, Part I, line 23;
   • Form 1065-B, Part I, line 5; or
   • Form 8825, line 15.

   In addition, the partnership must report, as an item of information using Code P1 in box 9 of Schedule K-1, the partner's distributive share of foreign trading gross receipts from Form 8873, line 15.

2. If the foreign trading gross receipts of the partnership for the tax year are $5 million or less and the partnership did not meet the foreign economic process requirements, it may not report the extraterritorial income exclusion as a non-separately stated item on its return. Instead, the partnership must report the following separately-stated items to the partners:
   • Using Code P1, enter in box 9 of Schedule K-1 the partner's distributive share of foreign trading gross receipts from the partnership's Form 8873, line 15.
   • Using Code P2, enter in box 9 of Schedule K-1 the partner's distributive share of the extraterritorial income exclusion from the partnership's Form 8873, line 55. For general partners only, identify the activity to which the exclusion relates.

Note: Upon request of a partner, the partnership should furnish a copy of the partnership's Form 8873 if that partner has a reduction for international boycott operations, illegal bribes, kickbacks, etc.

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