See Trade or Business Activities on page 3 and Rental Activities on page 2.

An activity is not a rental activity if any of the following exceptions are met.

If an activity meets any of the five exceptions listed above, it is not a rental activity. You must then determine:

If the rental activity did not meet any of the five exceptions, it is generally a passive activity. Special rules apply if you conduct the rental activity through a publicly traded partnership (PTP). See Publicly Traded Partnerships (PTPs) on page 15.

If the rental activity is not conducted through a PTP, the passive rental activity is entered in Worksheet 1, 2, 3, or 4 on pages 10 and 11.

Worksheet 1 is for credits (other than rehabilitation credits and low-income housing credits) from passive rental real estate activities in which you actively participated. See Special Allowance for Rental Real Estate Activities on page 3.

Worksheet 2 is for rehabilitation credits from passive rental real estate activities and low-income housing credits for property placed in service before 1990. This worksheet is also used for low-income housing credits from a partnership, S corporation, or other pass-through entity if your interest in the pass-through entity was acquired before 1990, regardless of the date the property was placed in service.

Worksheet 3 is for low-income housing credits for property placed in service after 1989 (unless held through a pass-through entity in which you acquired your interest before 1990).

Worksheet 4 is for credits from passive trade or business activities in which you did not materially participate and passive rental real estate activities in which you did not actively participate (but not rehabilitation credits from passive rental real estate activities or low-income housing credits).

If you actively participated in a passive rental real estate activity, you may be able to claim credits from the activity for the tax attributable to a special allowance of up to $25,000, reduced by any passive losses, including the commercial revitalization deduction, allowed under this exception on Form 8582, Passive Activity Loss Limitations.

The special allowance also applies to low-income housing credits and rehabilitation credits from a rental real estate activity, even if you did not actively participate in the activity. The credits allowed under the special allowance are in addition to the credits allowed for the tax attributable to net passive income.

The special allowance is not available if you were married at the end of the year, are filing a separate return for the year, and lived with your spouse at any time during the year.

Only an individual, a qualifying estate, or a qualified revocable trust that made an election to treat the trust as part of the decedent's estate may actively participate in a rental real estate activity. Unless future regulations provide an exception, limited partners are not treated as actively participating in a partnership's rental real estate activity.

A qualifying estate is the estate of a decedent for tax years ending less than 2 years after the date of the decedent's death if the decedent would have satisfied the active participation requirements for the rental real estate activity for the tax year the decedent died.

A qualified revocable trust may elect to be treated as part of a decedent's estate for purposes of the special allowance for active participation in rental real estate activities. The election must be made by both the executor (if any) of the decedent's estate and the trustee of the revocable trust. For details, see Regulations section 1.645-1.

You are not considered to actively participate in a rental real estate activity if at any time during the tax year your interest (including your spouse's interest) in the activity was less than 10% (by value) of all interests in the activity.

Active participation is a less stringent requirement than material participation (see Material Participation on this page). You may be treated as actively participating if, for example, you participated in making management decisions or arranging for others to provide services (such as repairs) in a significant and bona fide sense. Management decisions that may count as active participation include:

If your modified adjusted gross income is more than $100,000 ($50,000 if married filing separately) but less than $150,000 ($75,000 if married filing separately), your special allowance is limited to 50% of the difference between $150,000 ($75,000 if married filing separately) and your modified adjusted gross income.

Generally, if your modified adjusted gross income is $150,000 or more ($75,000 or more if married filing separately), there is no special allowance.

However, for low-income housing credits for property placed in service before 1990 and for rehabilitation credits, the limits on modified adjusted gross income are increased. If your modified adjusted gross income is more than $200,000 ($100,000 if married filing separately) but less than $250,000 ($125,000 if married filing separately), your special allowance is limited to 50% of the difference between $250,000 ($125,000 if married filing separately) and your modified adjusted gross income.

If your modified adjusted gross income is $250,000 or more ($125,000 or more if married filing separately), there is no special allowance.

No modified adjusted gross income limitation applies when figuring the special allowance for low-income housing credits for property placed in service after 1989 (other than from a pass-through entity in which you acquired your interest before 1990).

Proof of participation.   You may prove your participation in an activity by any reasonable means. You do not have to maintain contemporaneous daily time reports, logs, or similar documents if you can establish your participation by other reasonable means. For this purpose, reasonable means include, but are not limited to, identifying services performed over a period of time and the approximate number of hours spent performing the services during that period, based on appointment books, calendars, or narrative summaries.

Tests for individuals.   You materially participated for the tax year in an activity if you satisfy at least one of the following tests.

Test for a spouse.   Participation by your spouse during the tax year in an activity you own may be counted as your participation in the activity, even if your spouse did not own an interest in the activity and whether or not you and your spouse file a joint return for the tax year.

Test for investors.   Work done as an investor in an activity is not treated as participation unless you were directly involved in the day-to-day management or operations of the activity. For purposes of this test, work done as an investor includes:

Special rules for limited partners.   If you were a limited partner in an activity, you generally did not materially participate in the activity. You did materially participate in the activity, however, if you met material participation test 1, 5, or 6 (see Tests for individuals) for the tax year.

  However, for purposes of the material participation tests, you are not treated as a limited partner if you also were a general partner in the partnership at all times during the partnership's tax year ending with or within your tax year (or, if shorter, during the portion of the partnership's tax year in which you directly or indirectly owned your limited partner interest).

  A limited partner's share of an electing large partnership's taxable income or loss from all trade or business and rental activities is treated as income or loss from the conduct of a single passive trade or business activity.

Special rules for certain retired or disabled farmers and surviving spouses of farmers.    Certain retired or disabled farmers and surviving spouses of farmers are treated as materially participating in a farming activity if the real property used in the activity meets the estate tax rules for special valuation of farm property passed from a qualifying decedent. See Temporary Regulations section 1.469-5T(h)(2).

Estates and trusts.   The PAC limitations apply to an estate or trust. See Temporary Regulations sections 1.469-1T(b)(2) and (3). The rules for determining material participation for this purpose have not yet been issued.

Example.   You have a significant ownership interest in a bakery and a movie theater in Baltimore and in a bakery and a movie theater in Philadelphia. Depending on all the relevant facts and circumstances, there may be more than one reasonable method for grouping your activities. For instance, the following groupings may or may not be permissible.

  Once you choose a grouping under these rules, you 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 your activities if your grouping fails to reflect one or more appropriate economic units and one of the primary purposes of your grouping is to avoid the passive activity limitations.

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

Activities conducted through partnerships, S corporations, and C corporations subject to section 469.   Once a partnership or corporation determines its activities under these rules, a partner or shareholder may use these rules to group those activities with:

  A partner or shareholder may not treat as separate activities those activities grouped together by the partnership or corporation.

Partial disposition of an activity.   You may treat the disposition of substantially all of an activity as a separate activity if you can prove with reasonable certainty:

Unallowed PACs, unlike unallowed passive activity losses, are not allowed when you dispose of your interest in an activity. However, you may elect to increase the basis of the credit property by the amount of the original basis reduction of the property to the extent that the credit has not been allowed under the passive activity rules. Unallowed PACs that are not used to increase the basis of the credit property are carried forward until they are allowed. To make the election, complete Form 8582-CR, Part VI. No basis adjustment may be elected on a partial disposition of your interest in a passive activity.

In 2006, John Jones purchased an interest as a limited partner in Partnership A. Mr. Jones is married and files a joint return. During 2006, the partnership placed in service a residential rental building that qualified for the low-income housing credit.