How to Recharacterize Income for a Significant Participation Passive Activity?

[mcguimax]

For a significant participation passive activity (greater than 100 hours but didn't materially participate), and if the gross income from all significant participation passive activities is more than your deductions from those activities, a part of your net income from each significant participation passive activity is treated as nonpassive income (I believe under Regs. Sec. 1.469-2T(f)(2)).

The instructions for recharacterizing are in Pub 925 and involves two worksheets (A and B) for which results end up on Worksheet 3 of Form 8582.

I cannot figure out how to recharacterize the income from an SPA to non-passive and generate these worksheets in ProConnect.  Entering greater than 100 hours in Part II of Shareholder info for the K-1 in  "Number of significant participation hours" does not trigger it.

The only way I can get the income to show up as non-passive is to check "not a passive activity" but that isn't correct as it does not recharacterize it properly or generate Form 8582.

I need to figure out how to do this for a return as it significantly affects the net investment income tax on Form 8960.

If anyone is aware of how to do this in ProConnect please let me know.  Thanks.

[TaxGuyBill]

I don't know how it is done in PTO, but in ProSeries you need to manually enter/change the 8960 for that type of thing.

[mcguimax]

Thanks Bill.  I can see how I could make the changes manually to 8960. But I’m wondering how I would make the entries on form 8582 and also schedule E as well. Does everything need to be modified manually in ProSeries? I don’t even see a way to do this for Form 8582 in PTO.  It seems as though there needs to be a better way, but perhaps the software isn’t built for this scenario. 

[TaxGuyBill · Accepted solution]

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@mcguimax wrote:

The only way I can get the income to show up as non-passive is to check "not a passive activity" but that isn't correct as it does not recharacterize it properly or generate Form 8582.

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How does it not recharacterize it properly?  If you are treating it as non-passive, it would not generate a 8592.

[mcguimax]

Hi Bill, thanks for your help.  I had been confused as I'm not really a tax guy and only prepare my own return.

After reading the instructions, I had been thinking that if I had net income from a Significant Participation Passive Activity, that it would need to be entered in the Worksheets A and B for SPPA's referred to in Pub 925 and end up on Form 8582 no matter what.  Now I am understanding that 8582 would only come into play if there was a combined net loss from SPPA's.

I bolded the section below from Pub 925 that I didn't catch before.  So now I think you are correct, I can just click the "Not a passive activity" and I should be OK.

It does still seem to me though that the software should recognize that it is an SPPA if you enter 100+ hours, and automatically recharacterize the overall income as non-passive for you (or leave it passive if it was overall loss).  But there may be a reason for that which I don't understand. 

At any rate, thanks again for your help.  This has helped to answer my question for this return.

from Pub 925:

Recharacterization of Passive Income

Net income from the following passive activities may have to be recharacterized and excluded from passive activity income.

• Significant participation passive activities,

If you’re engaged in or have an interest in one of these activities during the tax year (either directly or through a partnership or an S corporation), combine the income and losses from the activity to determine if you have a net loss or net income from that activity.

If the result is a net loss, treat the income and losses the same as any other income or losses from that type of passive activity (trade or business activity or rental activity).

If the result is net income, don’t enter any of the income or losses from the activity or property on Form 8582 or its worksheets. Instead, enter income or losses on the form and schedules you normally use. However, see Significant Participation Passive Activities , later, if the activity is a significant participation passive activity and you also have a net loss from a different significant participation passive activity.

[mcguimax]

Just as soon as I marked solved, then I noticed a new problem.

I am receiving the following critical diagnostic:

Currently the total significant participation hours for all passive activities total less than the 501 hours needed to automatically make the activities non-passive. Please review your input and either continue entering activities until the total hours for all activities combined is greater than 500 hours, or remove the significant participation hours input from each activity.

It doesn't seem like this should happen.  It seems like there needs to be a way to identify an activity as a significant passive participation activity so that I don't get this diagnostic.