A partnership may elect to expense property under IRC §179 only if the partnership uses the property predominantly (more than 50%) in the active conduct of a trade or business. The determination of whether the partnership is actively conducting a business is made by taking into account the activities of all partners.
Example: ABC limited partnership owns a rental commercial building. The general partner actively manages all aspects of the rental business. Although the limited partners are passive partners the partnership may elect to expense any qualifying section 179 property placed in service during the tax year. In this case, the activities of the general partner alone are significant enough to meet the active conduct of a trade or business requirement.
Deduction Limited to Taxable Income
The IRC §179 deduction that a partnership may pass through is limited to the partnership’s taxable income from the active conduct of its trade or business. The portion of a section 179 deduction disallowed by reason of the taxable income limitation is carried forward by the partnership until it has sufficient taxable income from the active conduct of its business to absorb the suspended deduction.
The taxable income limitation is also applied separately at the partner level.
A partner may only take taxable income from a partnership into account in applying the active taxable income limit if the partner is actively engaged in the partnership’s trade or business. Taxable income from other trades or businesses actively conducted by the partner, including wages from employment, count toward the partner’s active taxable income.
EXAMPLE: Assume that ABC partnership above elected to expense $100,000 of section 179 property and that the taxable income from the active conduct of the rental business is only $90,000. ABC may only pass-thru $90,000. ABC has a $10,000 carryforward which is eligible for pass-thru in a carryforward year in which there is active taxable income not offset by section 179 expensing on property acquired in the carryforward year.
EXAMPLE: Assume that A, a limited partner in ABC partnership above, received a $30,000 section 179 allocation. In applying the taxable income limitation, A cannot take into account any amount allocated from ABC because A is a passive partner. A may only deduct the $30,000 if A has taxable income from the active conduct of a different trade or business, including wages from employment. If A only has $10,000 of active taxable income, A may deduct $10,000 and carryforward $20,000.
Determining Partnership Taxable Income
A partnership’s active taxable income is computed by aggregating the net income from all of the trades or businesses actively conducted by the partnership. The net income is determined by aggregating partnership items (e.g., income, deductions) derived from each trade or business. Each partner who actively participates in any trade or business actively conducted by the partnership is allocated a share of the active taxable income from all of the partnership’s active trade or businesses.
Dollar and Investment Limitations
The section 179 dollar and investment limitations are applied at the partner and partnership level. In a tax year beginning in 2018, the total of all section 179 deduction distributions by a partnership may not exceed $1 million (the dollar limitation). The $1 million limitation is reduced by the cost of qualifying property in excess of $2,500,000 placed in service by the partnership (the investment limitation).
A partner may deduct no more than $1 million, including deductions passed through by the partnership. However, in applying the investment limitation, section 179 property purchased by the partnership does not count toward the partner’s separately applied $2,500,000 investment ceiling.
Amounts that are not deductible due to the dollar and investment limitations are not carried forward.
What is the Active Conduct of a Partnership Business?
Whether an asset is used in a trade or business by a partnership is determined by reference to the generally applicable principles of IRC §162 for deducting business expenses. Property used in an investment activity (IRC §212) does not qualify for expensing but may be depreciated. Investment property is also eligible for bonus depreciation.
Using property in a trade or business, however, is not sufficient for purposes of section 179. A partnership must actively conduct the trade or business. This standard is less stringent than the material participation standard of the passive loss rules of IRC §469.
The section 179 regulations provide minimal guidance (Reg. §1.179-2). Specifically:
- All facts and circumstances are considered in determining whether the partnership conducts an active trade or business;
- The facts and circumstances are applied in light of the purpose of the active conduct requirement as it applies to the taxable income limitation; and
- A partnership actively conducts a trade or business if the partnership meaningfully participates in the management or operations of the trade or business
Similar standards apply in determining whether a partner actively participates in the partnership’s trade or business.
There is a near absence of cases and rulings dealing with the section 179 active trade or business requirement. However, it may be possible to glean some additional insight from IRS Notice 2006-77 which deals with the former Go-Zone bonus depreciation deduction (IRC §1400N(d)). The notice adopts the meaningful participation standard of section 179 but effectively provides that activities performed by others on behalf of the partnership in the management or operations of the business are attributable to the partnership. Several examples are provided, including an example that concludes that a partnership that rents real property pursuant to a triple-net-lease is not engaged in the conduct of an active trade or business.
For additional information regarding partnerships and the active trade or business requirement, see CCH Answer Connect Topic Page entitled Section 179 Deduction Calculation.
By Ray G. Suelzer, J.D., LL.M.