General Instructions

Changes To Note

• The Job Creation and Worker Assistance Act of 2002 clarified that any election to recognize gain in a deemed sale of a passive activity (or former passive activity) held on January 1, 2001, is not treated as a disposition of the entire interest in the passive activity (that is, section 469(g)(1)(A) does not apply with regard to the deemed sale). If the corporation made such an election and treated the deemed sale as the disposition of its entire interest in the activity on its 2000 or 2001 tax return, it must file an amended return.
• If a pass-through entity in which the corporation had a direct or indirect ownership interest loaned money to or borrowed money from (a) the corporation or (b) another identically owned pass-through entity, and the proceeds were used in a passive activity, part or all of the interest income or expense may be allocable to a passive activity. See Self-Charged Interest on page 5.

Purpose of Form

Form 8810 is used by personal service corporations and closely held corporations to figure the amount of any passive activity loss or credit for the current tax year and the amount of losses and credits from passive activities allowed on the corporation's tax return. It is also used to make the election to increase the basis of credit property when the corporation disposes of its interest in an activity for which it has an unused credit.

Generally, passive activities include trade or business activities in which the corporation did not materially participate for the tax year, and rental activities regardless of its participation.

Who Must File

Personal service corporations and closely held corporations that have losses or credits (including prior year unallowed losses and credits) from passive activities must file Form 8810.

A personal service corporation has a passive activity loss for the year if the total losses (including prior year unallowed losses) from its passive activities exceed the total income from its passive activities. A closely held corporation has a passive activity loss for the year if the total losses (including prior year unallowed losses) from all its passive activities exceed the sum of the total income from all its passive activities and its net active income.

A personal service corporation has a passive activity credit for the year if its credits from passive activities (including prior year unallowed credits) exceed the tax attributable to net passive income. A closely held corporation has a passive activity credit for the year if its credits from passive activities (including prior year unallowed credits) exceed the sum of the tax attributable to net passive income and the tax attributable to net active income.

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

Definitions

Except as otherwise indicated, the following terms are defined as shown below.

Personal service corporation.   A personal service corporation is a corporation whose principal activity for the testing period (defined below) for the tax year is the performance of personal services. The services must be substantially performed by employee-owners. Employee-owners must own more than 10% of the fair market value of the corporation's outstanding stock on the last day of the testing period.

Testing period.   Generally, the testing period for a tax year is the prior tax year. The testing period for a new corporation starts with the first day of its first tax year and ends on the earlier of:

• The last day of its first tax year or
• The last day of the calendar year in which the first tax year began.

Principal activity.   The principal activity of a corporation is considered to be the performance of personal services if, during the testing period, the corporation's compensation costs for the performance of personal services are more than 50% of its total compensation costs.

Performance of personal services.   Personal services are those performed in the health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting fields (as defined in Temporary Regulations section 1.448-1T(e)). The term performance of personal services includes any activity involving the performance of personal services in these areas.

Substantial performance by employee-owners.   Personal services are substantially performed by employee-owners if, for the testing period, more than 20% of the corporation's compensation costs for the performance of personal services are for services performed by employee-owners.

Employee-owner.   A person is considered to be an employee-owner if the person is an employee of the corporation on any day of the testing period, and owns any outstanding stock of the corporation on any day of the testing period. Stock ownership is determined under the attribution rules of section 318, except that any is substituted for 50 percent or more in value in section 318(a)(2)(C).

For more information about personal service corporations, see Regulations section 1.441-3(c).

Closely held corporation.   A corporation is a closely held corporation if at any time during the last half of the tax year more than 50% in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals, and the corporation is not a personal service corporation.

Certain organizations are treated as individuals for this test (see section 542(a)). For rules of determining stock ownership, see section 544 (as modified by section 465(a)(3)).

Other Passive Activity Terms

Net income   means the excess of current year income over current year deductions from the activity. This includes any current year gains or losses from the disposition of assets or an interest in the activity.

Net loss   means the excess of current year deductions over current year income from the activity. This includes any current year gains or losses from the disposition of assets or an interest in the activity.

Overall gain   means the excess of the net income from the activity over the prior year unallowed losses from the activity.

Overall loss   means the excess of the prior year unallowed losses from the activity over the net income from the activity or the prior year unallowed losses from the activity plus the net loss from the activity.

Prior year unallowed losses   means the deductions and losses from an activity that were disallowed under the passive activity loss (PAL) limitations in a prior year and carried forward to the tax year under section 469(b). See Regulations section 1.469-1(f)(4).

Coordination With Other Limitations

Generally, PALs are subject to other limitations (for example, basis, section 163(j) interest deduction limitations, and at-risk limitations) before they are subject to the passive loss limitations. Once a loss becomes allowable under these other limitations, the corporation must determine whether the loss is limited under the passive loss rules. See Form 6198, At-Risk Limitations, for details on the at-risk rules. Also, capital losses that are allowable under the passive loss rules may be limited under the capital loss limitations of section 1211(a). Percentage depletion deductions that are allowable under the passive loss rules may also be limited under section 613A(d).

Special Rules for Consolidated Group

The passive activity loss and passive activity credit of an affiliated group of corporations filing a consolidated return for the tax year (a consolidated group) are determined by taking into account the following items of each member of the group:

• Passive activity gross income and deductions;
• Gain or loss on dispositions;
• Net active income (for a consolidated group treated as a closely held corporation); and
• Credits from passive activities.

Activities That Are Not Passive Activities

The following are not passive activities.

1. Trade or business activities in which the corporation materially participated for the tax year.
2. Any rental real estate activity in which the corporation materially participated if the corporation was a closely held corporation that derived more than 50% of its gross receipts from real property trades or businesses in which it materially participated.

   For purposes of this rule, each interest in rental real estate is a separate activity, unless the corporation elects to treat all interests in rental real estate as one activity. The corporation makes the election by attaching a statement to its original income tax return for the tax year. See Regulations section 1.469-9(g) for details on how to make or revoke this election.

   A real property trade or business is any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.

   Note:   If an activity qualifies for the exception described above in 2002, but has a prior year unallowed passive loss, the prior year unallowed loss is treated as a loss from a former passive activity. See Former Passive Activities on page 6.

3. A working interest in an oil or gas well. The working interest in an oil or gas well must be held directly or through an entity that does not limit the corporation's liability (such as a general partner interest in a partnership). In this case, it does not matter whether the corporation materially participated in the activity for the tax year.

   If, however, the corporation's liability was limited for part of the year (for example, the corporation converted its general partner interest to a limited partner interest during the year), some of the corporation's income and losses from the working interest may be treated as passive activity gross income and passive activity deductions. See Temporary Regulations section 1.469-1T(e)(4)(ii).

4. An activity of trading personal property for the account of owners of interests in the activity. For purposes of this rule, personal property means property that is actively traded, such as stocks, bonds, and other securities. See Temporary Regulations section 1.469-1T(e)(6) for more details.

   Generally, income, losses, and credits from these activities are not entered on Form 8810. However, losses and credits from these activities may be subject to limitations other than the passive loss and credit rules.

Rental Activities

A rental activity is a passive activity even if the corporation materially participated in the activity unless it meets the requirements described in item 2 in Activities That Are Not Passive Activities above. In addition, if the corporation meets any of the five exceptions listed below, the rental of the property is not treated as a rental activity. See Reporting Income, Deductions, Losses, and Credits From the Activities on page 3 if the corporation meets any of the exceptions.

An activity is a rental activity if tangible property (real or personal) is used by customers or held for use by customers and the gross income (or expected gross income) from the activity represents amounts paid (or to be paid) mainly for the use of the property. It does not matter whether the use of the property is under a lease, a service contract, or some other arrangement.

Exceptions

An activity is not a rental activity if:

1. The average period of customer use (see 1b below) of the rental property is:
   1. 7 days or less or
   2. 30 days or less and significant personal services (see below) were provided in making the rental property available for customer use.

   Figure the average period of customer use for a class of property by dividing the total number of days in all rental periods by the number of rentals during the tax year. If the activity involves renting more than one class of property, multiply the average period of customer use of each class by the ratio of the gross rental income from that class to the activity's total gross rental income. The activity's average period of customer use equals the sum of these class-by-class average periods weighted by gross income. See Regulations section 1.469-1(e)(3)(iii).

   Significant personal services include only services performed by individuals. To determine if personal services are significant, all the relevant facts and circumstances are taken into consideration, including the frequency of the services, the type and amount of labor required to perform the services, and the value of the services relative to the amount charged for the use of the property.

   Significant personal services do not include excluded services. See Temporary Regulations section 1.469-1T(e)(3)(iv)(B).

2. Extraordinary personal services were provided in making the rental property available for customer use.

   Extraordinary personal services are services provided in making rental property available for customer use only if they are performed by individuals and the customers' use of the property is incidental to their receipt of the services.

3. Rental of the property is incidental to a nonrental activity.

   The rental of property is incidental to an activity of holding property for investment if the main purpose of holding the property 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 fair market value (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:

   1. The corporation owned an interest in the trade or business activity during the tax year;
   2. 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
   3. 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 such 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 the 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 below) 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 below.

If the corporation meets any of the five exceptions listed above 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 on page 5 apply. See the PTP rules on page 10.

If none of the special rules apply, use Worksheets 1 and 2 on page 7 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 on page 11 to figure the amount to enter in Part II of Form 8810.

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