[Federal Register Volume 60, Number 246 (Friday, December 22, 1995)]
[Rules and Regulations]
[Pages 66496-66502]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-30872]



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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8645]
RIN 1545-AS38


Rules for Certain Rental Real Estate Activities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations providing rules for 
rental real estate activities of taxpayers engaged in certain real 
property trades or businesses. The regulations reflect changes to the 
law made by the Omnibus Budget Reconciliation Act of 1993, and affect 
taxpayers subject to the limitations on passive activity losses and 
passive activity credits.

DATES: These regulations are effective on January 1, 1995. See 
Sec. 1.469-11 for applicability.

ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (TD 8645), room 5228, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. In the alternative, submissions may be hand delivered between 
the hours of 8:00 a.m. and 5:00 p.m. to: CC:DOM:CORP:T:R (TD 8645), 
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW, 
Washington, DC.

FOR FURTHER INFORMATION CONTACT: William M. Kostak at (202) 622-3080 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act (44 U.S.C. 3504(h)) 
under control number 1545-AS38. The estimated annual burden per 
respondent varies from 0.10 hours to 0.25 hours, depending on 
individual circumstances, with an estimated average of 0.15 hours.
    Comments concerning the accuracy of this burden estimate and 
suggestions for reducing this burden should be sent to the Internal 
Revenue Service, Attn: IRS Reports Clearance Officer, PC:FP, 
Washington, DC 20224, and to the Office of Management and Budget, Attn: 
Desk Officer for the Department of the Treasury, Office of Information 
and Regulatory Affairs, Washington, DC 20503.

Background

    This document amends 26 CFR part 1 to provide rules relating to the 
treatment of rental real estate activities of certain taxpayers under 
the passive activity loss and credit limitations of section 469. 
Section 469 disallows losses from passive activities to the extent they 
exceed income from passive activities and similarly disallows credits 
from passive activities to the extent they exceed tax liability 
allocable to passive activities. In general, passive activities are 
activities in which the taxpayer does not materially participate. In 
addition, until the enactment of the Omnibus Budget Reconciliation Act 
of 1993 (OBRA 1993), all rental activities (including those in which a 
taxpayer materially participated) were passive.
    OBRA 1993 added section 469(c)(7), which provides that rental real 
estate activities of qualifying taxpayers are not subject to the rule 
that treats all rental activities as passive. Thus, a rental real 
estate activity of a qualifying taxpayer is not passive if the taxpayer 
materially participates in the activity. Further, section 469(c)(7) 
provides that each of a qualifying taxpayer's interests in rental real 
estate is treated as a separate activity unless the taxpayer elects to 
treat all interests in rental real estate as a single activity.
    On January 10, 1995, the IRS published in the Federal Register a 
notice of proposed rulemaking (60 FR 2557) to provide guidance 
regarding section 469(c)(7). A number of public comments were received 
concerning the proposed regulations, and a public hearing was held on 
May 11, 1995. After consideration of the comments received, the 
proposed regulations are adopted as revised by this Treasury decision.

Explanation of Provisions

I. General Background

    The proposed regulations provide rules for determining whether a 
taxpayer qualifies for treatment under section 469(c)(7). The proposed 
regulations also provide rules for determining the rental real estate 
activities of qualifying taxpayers for purposes of section 469. Except 
for modifications in response to comments received on the proposed 
regulations, 

[[Page 66497]]
the final regulations generally adopt the rules contained in the 
proposed regulations.

II. Public Comments

    Several comments requested that the Service reconsider the rule in 
the proposed regulations prohibiting qualifying taxpayers from grouping 
rental real estate activities with other activities in determining 
whether the taxpayers materially participate in the rental real estate 
activities. After careful consideration, the final regulations adopt 
the rule in the proposed regulations because that position is 
consistent with the statutory language and the legislative history.
    Several comments suggested that the rule in the proposed 
regulations prohibiting the grouping of rental real estate activities 
with other activities be modified to allow qualifying taxpayers to 
group the activities of development or construction of rental real 
estate with rental real estate activities. The final regulations do not 
adopt this modification because in most cases development and 
construction activities are separate and distinct from rental 
activities. In addition, this modification would introduce significant 
administrative difficulties in determining which development activities 
or construction activities qualify. However, the IRS and Treasury 
Department invite comments concerning whether the material 
participation tests in Sec. 1.469-5T(a) should be amended to include a 
look-back material participation test for taxpayers significantly 
involved in the development or construction of their rental real estate 
interests.
    Several comments requested clarification regarding whether a 
qualifying taxpayer's participation in a management activity may count 
towards material participation in a rental real estate activity if the 
management activity includes the management of rental real estate owned 
by the taxpayer. The final regulations clarify that a qualifying 
taxpayer may participate in a rental real estate activity through 
participation in a management activity. In determining whether the 
taxpayer materially participates in the rental real estate activity, 
however, work the taxpayer performs in the management activity is taken 
into account only to the extent it is performed in managing the 
taxpayer's own rental real estate. The final regulations also clarify 
that a qualifying taxpayer who owns rental real estate through an 
entity, including a C corporation that is subject to section 469, may 
count work performed by the taxpayer in managing the rental real estate 
of the entity in establishing material participation in the taxpayer's 
rental real estate activities. Thus, if a qualifying taxpayer owns some 
interests in rental real estate through a closely held C corporation 
and makes the election to treat all interests in rental real estate as 
a single activity, the aggregate rental real estate activity will 
include those interests held through the closely held C corporation for 
purposes of material participation.
    One comment requested that the regulations modify the definition of 
trade or business to clarify that a taxpayer's real property trades or 
businesses are determined without regard to the taxpayer's grouping of 
activities under Sec. 1.469-4. The final regulations clarify that a 
taxpayer's grouping of activities under Sec. 1.469-4 does not control 
the determination of the taxpayer's real property trades or businesses 
for purposes of this section.
    Several comments requested that the regulations provide a detailed 
definition of real property trades or businesses beyond the cross-
reference to section 469(c)(7)(C). However, to avoid complex and 
mechanical rules, the final regulations do not adopt a detailed 
definition of real property trades or businesses. Instead, the 
regulations provide that taxpayers may use any reasonable method for 
determining their real property trades or businesses.
    Several comments requested that the final regulations modify the 
rule in the proposed regulations providing that only employees who are 
five-percent owners of their employer at all times during the taxable 
year may treat personal services performed as an employee as services 
performed in a real property trade or business. The comments suggested 
that the regulations should take into account personal services 
performed by employees that are five-percent owners for a significant 
portion of a taxable year. In response to these comments, the final 
regulations are modified to provide that an employee may count services 
performed in a real property trade or business during the portion of 
the taxable year that the employee is a five-percent owner in the 
employer.
    Several comments requested clarification concerning whether a 
qualifying taxpayer that makes an election to treat all interests in 
rental real estate as a single activity will be treated as having a 
single rental real estate activity for purposes of the former passive 
activity rule under section 469 (f). In addition, comments requested 
that the regulations be modified to provide that qualifying taxpayers 
that make the aggregation election will be treated as having separate 
activities for purposes of the disposition rules under section 469(g) 
and Sec. 1.469-4(g). In response to these comments, the final 
regulations clarify that a qualifying taxpayer that makes the election 
to treat all interests in rental real estate as a single rental real 
estate activity will be treated as having a single activity for all 
purposes of section 469, including sections 469(f) and (g). The 
statutory language and the legislative history do not support a rule 
allowing a qualifying taxpayer to treat all interests in rental real 
estate as a single activity for purposes of material participation and 
section 469(f), but as separate activities for purposes of section 
469(g).
    In addition, in response to comments, the final regulations provide 
an example illustrating the operation of the former passive activity 
rule for qualifying taxpayers that make the election to treat all 
interests in rental real estate as a single activity. This example 
illustrates that qualifying taxpayers that make the aggregation 
election may use current net income from the aggregate rental real 
estate activity to offset the prior-year disallowed passive losses of 
the aggregate rental real estate activity, regardless of which rental 
real estate interests within that activity produced the income or 
prior-year losses.
    Some comments requested that the regulations permit qualifying 
taxpayers to make or revoke the aggregation election on an amended 
income tax return. After careful consideration of this issue, the final 
regulations adopt the rule in the proposed regulations that aggregation 
elections must be made or revoked on an original return. The final 
regulations provide, however, that the election may be revoked in any 
year in which the facts are materially changed from those in the 
taxable year for which the election was made.
    In addition, one comment requested clarification as to what 
constitutes a material change in the facts and circumstances that would 
allow a taxpayer to revoke an aggregation election. However, the final 
regulations do not provide an example or bright-line rule for 
determining when a material change in the facts and circumstances has 
occurred, because this determination is intended to be a broad factual 
inquiry. Providing an example or bright-line rule may inappropriately 
restrict the scope of that inquiry.
    One comment requested the modification of the rule in the proposed 
regulations that the aggregation election has no effect in years the 
taxpayer is not a qualifying taxpayer. Instead, the comment suggested 
that, for ease of administration and compliance, the 

[[Page 66498]]
aggregation election should be binding and irrevocable for all future 
years, including years in which the taxpayer is not a qualifying 
taxpayer. However, the final regulations adopt the rule in the proposed 
regulations because the position advocated by the comment would be 
unfavorable to many taxpayers and would not significantly improve 
administration.
    Several comments requested that the regulations modify the rule in 
the proposed regulations treating each rental real estate interest of a 
passthrough entity as a separate interest of a person owning a fifty-
percent or greater interest in the capital, gain, loss, income, 
deduction, or credit of the entity at any time during a taxable year. A 
commentator stated that this rule is burdensome on many passthrough 
entities and should be eliminated or modified. The final regulations 
modify this rule so that it applies only when a qualifying taxpayer 
owns a fifty-percent or greater interest in the capital, profits, or 
losses of a passthrough entity for a taxable year. Accordingly, this 
rule will not apply if a qualifying taxpayer owns a fifty-percent or 
greater interest in a single item of income or deduction but does not 
own a fifty-percent or greater interest in the overall capital, 
profits, or losses of the passthrough entity.
    In response to one comment, the final regulations also clarify the 
application of the fifty-percent ownership rule to tiered passthrough 
entities. The final regulations provide that if a passthrough entity 
owns a fifty-percent or greater interest in the capital, profits, or 
losses of another passthrough entity for a taxable year, each interest 
in rental real estate of the lower-tier entity will be a separate 
interest in rental real estate of the upper-tier entity.
    In response to another comment, the final regulations clarify that 
section 469(i) applies after the rules of section 469(c)(7) are 
applied. Accordingly, the $25,000 offset will be applied only against 
passive losses from rental real estate activities, and not against 
losses that are allowable as a result of section 469(c)(7). In 
addition, the final regulations clarify that adjusted gross income for 
purposes of section 469(i) is not reduced by any losses from rental 
real estate that are allowable as a result of section 469(c)(7).
    Several comments requested a modification to the effective date 
provision, to provide that aggregation elections made for taxable years 
beginning before January 1, 1995, are not binding for future years. 
Because taxpayers had sufficient notice of the rules of section 
469(c)(7) and these regulations, this modification is unnecessary and 
would add administrative complexity. Accordingly, the final regulations 
adopt the effective date provision of the proposed regulations.
    Finally, in response to a comment, the activity regrouping rule of 
Sec. 1.469-4(e)(2) is clarified to provide that a taxpayer may not 
regroup activities unless the taxpayer's original grouping was clearly 
inappropriate or there has been a material change in the facts and 
circumstances that makes the original grouping clearly inappropriate.

III. Effective Dates

    In general, section 469(c)(7) applies for taxable years beginning 
after December 31, 1993. These regulations are effective for taxable 
years beginning on or after January 1, 1995. These regulations are also 
effective for elections under section 469(c)(7)(A) and paragraph (g) of 
these regulations that are made with returns filed on or after January 
1, 1995.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in EO 12866. Therefore, a 
regulatory assessment is not required. It also has been determined that 
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) 
and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to 
these regulations, and, therefore, a Regulatory Flexibility Analysis is 
not required. Pursuant to section 7805(f) of the Internal Revenue Code, 
the notice of proposed rulemaking preceding these regulations was 
submitted to the Small Business Administration for comment on its 
impact on small business.

Drafting Information

    The principal author of these regulations is William M. Kostak, 
Office of Assistant Chief Counsel (Passthroughs and Special 
Industries), IRS. However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805. * * *

    Section 1.469-9 also issued under 26 U.S.C. 469(c)(6), (h)(2), 
and (l)(1).

    Par. 2. Section 1.469-0 is amended by:
    1. Revising the entry for Sec. 1.469-4(h).
    2. Revising the heading for Sec. 1.469-9 and adding entries for 
paragraphs (a) through (j) of Sec. 1.469-9.
    3. Revising the entry for Sec. 1.469-11(b)(2) and removing the 
entries for Sec. 1.469-11(b)(2)(i) and (ii).
    4. Revising the entry for Sec. 1.469-11(b)(3).
    5. Adding an entry for Sec. 1.469-11(b)(4).
    6. The revisions and additions read as follows:

Sec. 1.469-0 Table of contents.

* * * * *

Sec. 1.469-4 Definition of Activity.

* * * * *
    (h) Rules for grouping rental real estate activities for 
taxpayers qualifying under section 469(c)(7).
* * * * *

Sec. 1.469-9 Rules for certain rental real estate activities.

    (a) Scope and purpose.
    (b) Definitions.
    (1) Trade or business.
    (2) Real property trade or business.
    (3) Rental real estate.
    (4) Personal services.
    (5) Material participation.
    (6) Qualifying taxpayer.
    (c) Requirements for qualifying taxpayers.
    (1) In general.
    (2) Closely held C corporations.
    (3) Requirement of material participation in the real property 
trades or businesses.
    (4) Treatment of spouses.
    (5) Employees in real property trades or businesses.
    (d) General rule for determining real property trades or 
businesses.
    (1) Facts and circumstances.
    (2) Consistency requirement.
    (e) Treatment of rental real estate activities of a qualifying 
taxpayer.
    (1) In general.
    (2) Treatment as a former passive activity.
    (3) Grouping rental real estate activities with other 
activities.
    (i) In general.
    (ii) Special rule for certain management activities.
    (4) Example.
    (f) Limited partnership interests in rental real estate 
activities.
    (1) In general.
    (2) De minimis exception.
    (g) Election to treat all interests in rental real estate as a 
single rental real estate activity.
    (1) In general.
    (2) Certain changes not material.
    (3) Filing a statement to make or revoke the election.
    (h) Interests in rental real estate held by certain passthrough 
entities. 

[[Page 66499]]

    (1) General rule.
    (2) Special rule if a qualifying taxpayer holds a fifty-percent 
or greater interest in a passthrough entity.
    (3) Special rule for interests held in tiered passthrough 
entities.
    (i) [Reserved].
    (j) $25,000 offset for rental real estate activities of 
qualifying taxpayers.
    (1) In general.
    (2) Example.
* * * * *

Sec. 1.469-11 Effective date and transition rules.

* * * * *
    (b) * * *
    (2) Additional transition rule for 1992 amendments.
    (3) Fresh starts under consistency rules.
    (i) Regrouping when tax liability is first determined under 
Project PS-1-89.
    (ii) Regrouping when tax liability is first determined under 
Sec. 1.469-4.
    (iii) Regrouping when taxpayer is first subject to section 
469(c)(7).
    (4) Certain investment credit property.
* * * * *
    Par. 3. Section 1.469-4 is amended by revising paragraphs (e) (1) 
and (2) and (h). The revisions read as follows:


Sec. 1.469-4  Definition of Activity.

* * * * *
    (e) * * *
    (1) Original groupings. Except as provided in paragraph (e)(2) of 
this section and Sec. 1.469-11, once a taxpayer has grouped activities 
under this section, the taxpayer may not regroup those activities in 
subsequent taxable years. Taxpayers must comply with disclosure 
requirements that the Commissioner may prescribe with respect to both 
their original groupings and the addition and disposition of specific 
activities within those chosen groupings in subsequent taxable years.
    (2) Regroupings. If it is determined that a taxpayer's original 
grouping was clearly inappropriate or a material change in the facts 
and circumstances has occurred that makes the original grouping clearly 
inappropriate, the taxpayer must regroup the activities and must comply 
with disclosure requirements that the Commissioner may prescribe.
* * * * *
    (h) Rules for grouping rental real estate activities for taxpayers 
qualifying under section 469(c)(7). See Sec. 1.469-9 for rules for 
certain rental real estate activities.
    Par. 4. Section 1.469-9 is revised to read as follows:


Sec. 1.469-9  Rules for certain rental real estate activities.

    (a) Scope and purpose. This section provides guidance to taxpayers 
engaged in certain real property trades or businesses on applying 
section 469(c)(7) to their rental real estate activities.
    (b) Definitions. The following definitions apply for purposes of 
this section:
    (1) Trade or business. A trade or business is any trade or business 
determined by treating the types of activities in Sec. 1.469-4(b)(1) as 
if they involved the conduct of a trade or business, and any interest 
in rental real estate, including any interest in rental real estate 
that gives rise to deductions under section 212.
    (2) Real property trade or business. Real property trade or 
business is defined in section 469(c)(7)(C).
    (3) Rental real estate. Rental real estate is any real property 
used by customers or held for use by customers in a rental activity 
within the meaning of Sec. 1.469-1T(e)(3). However, any rental real 
estate that the taxpayer grouped with a trade or business activity 
under Sec. 1.469-4(d)(1)(i)(A) or (C) is not an interest in rental real 
estate for purposes of this section.
    (4) Personal services. Personal services means any work performed 
by an individual in connection with a trade or business. However, 
personal services do not include any work performed by an individual in 
the individual's capacity as an investor as described in Sec. 1.469-
5T(f)(2)(ii).
    (5) Material participation. Material participation has the same 
meaning as under Sec. 1.469-5T. Paragraph (f) of this section contains 
rules applicable to limited partnership interests in rental real estate 
that a qualifying taxpayer elects to aggregate with other interests in 
rental real estate of that taxpayer.
    (6) Qualifying taxpayer. A qualifying taxpayer is a taxpayer that 
owns at least one interest in rental real estate and meets the 
requirements of paragraph (c) of this section.
    (c) Requirements for qualifying taxpayers--(1) In general. A 
qualifying taxpayer must meet the requirements of section 469(c)(7)(B).
    (2) Closely held C corporations. A closely held C corporation meets 
the requirements of paragraph (c)(1) of this section by satisfying the 
requirements of section 469(c)(7)(D)(i). For purposes of section 
469(c)(7)(D)(i), gross receipts do not include items of portfolio 
income within the meaning of Sec. 1.469-2T(c)(3).
    (3) Requirement of material participation in the real property 
trades or businesses. A taxpayer must materially participate in a real 
property trade or business in order for the personal services provided 
by the taxpayer in that real property trade or business to count 
towards meeting the requirements of paragraph (c)(1) of this section.
    (4) Treatment of spouses. Spouses filing a joint return are 
qualifying taxpayers only if one spouse separately satisfies both 
requirements of section 469(c)(7)(B). In determining the real property 
trades or businesses in which a married taxpayer materially 
participates (but not for any other purpose under this paragraph (c)), 
work performed by the taxpayer's spouse in a trade or business is 
treated as work performed by the taxpayer under Sec. 1.469-5T(f)(3), 
regardless of whether the spouses file a joint return for the year.
    (5) Employees in real property trades or businesses. For purposes 
of paragraph (c)(1) of this section, personal services performed during 
a taxable year as an employee generally will be treated as performed in 
a trade or business but will not be treated as performed in a real 
property trade or business, unless the taxpayer is a five-percent owner 
(within the meaning of section 416(i)(1)(B)) in the employer. If an 
employee is not a five-percent owner in the employer at all times 
during the taxable year, only the personal services performed by the 
employee during the period the employee is a five-percent owner in the 
employer will be treated as performed in a real property trade or 
business.
    (d) General rule for determining real property trades or 
businesses--(1) Facts and circumstances. The determination of a 
taxpayer's real property trades or businesses for purposes of paragraph 
(c) of this section is based on all of the relevant facts and 
circumstances. A taxpayer may use any reasonable method of applying the 
facts and circumstances in determining the real property trades or 
businesses in which the taxpayer provides personal services. Depending 
on the facts and circumstances, a real property trade or business 
consists either of one or more than one trade or business specifically 
described in section 469(c)(7)(C). A taxpayer's grouping of activities 
under Sec. 1.469-4 does not control the determination of the taxpayer's 
real property trades or businesses under this paragraph (d).
    (2) Consistency requirement. Once a taxpayer determines the real 
property trades or businesses in which personal services are provided 
for purposes of paragraph (c) of this section, the taxpayer may not 
redetermine those real property trades or businesses in subsequent 
taxable years unless the original determination was clearly 
inappropriate or there has been a material change in the facts and 

[[Page 66500]]
circumstances that makes the original determination clearly 
inappropriate.
    (e) Treatment of rental real estate activities of a qualifying 
taxpayer--(1) In general. Section 469(c)(2) does not apply to any 
rental real estate activity of a taxpayer for a taxable year in which 
the taxpayer is a qualifying taxpayer under paragraph (c) of this 
section. Instead, a rental real estate activity of a qualifying 
taxpayer is a passive activity under section 469 for the taxable year 
unless the taxpayer materially participates in the activity. Each 
interest in rental real estate of a qualifying taxpayer will be treated 
as a separate rental real estate activity, unless the taxpayer makes an 
election under paragraph (g) of this section to treat all interests in 
rental real estate as a single rental real estate activity. Each 
separate rental real estate activity, or the single combined rental 
real estate activity if the taxpayer makes an election under paragraph 
(g), will be an activity of the taxpayer for all purposes of section 
469, including the former passive activity rules under section 469(f) 
and the disposition rules under section 469(g). However, section 469 
will continue to be applied separately with respect to each publicly 
traded partnership, as required under section 469(k), notwithstanding 
the rules of this section.
    (2) Treatment as a former passive activity. For any taxable year in 
which a qualifying taxpayer materially participates in a rental real 
estate activity, that rental real estate activity will be treated as a 
former passive activity under section 469(f) if disallowed deductions 
or credits are allocated to the activity under Sec. 1.469-1(f)(4).
    (3) Grouping rental real estate activities with other activities--
(i) In general. For purposes of this section, a qualifying taxpayer may 
not group a rental real estate activity with any other activity of the 
taxpayer. For example, if a qualifying taxpayer develops real property, 
constructs buildings, and owns an interest in rental real estate, the 
taxpayer's interest in rental real estate may not be grouped with the 
taxpayer's development activity or construction activity. Thus, only 
the participation of the taxpayer with respect to the rental real 
estate may be used to determine if the taxpayer materially participates 
in the rental real estate activity under Sec. 1.469-5T.
    (ii) Special rule for certain management activities. A qualifying 
taxpayer may participate in a rental real estate activity through 
participation, within the meaning of Secs. 1.469-5(f) and 5T(f), in an 
activity involving the management of rental real estate (even if this 
management activity is conducted through a separate entity). In 
determining whether the taxpayer materially participates in the rental 
real estate activity, however, work the taxpayer performs in the 
management activity is taken into account only to the extent it is 
performed in managing the taxpayer's own rental real estate interests.
    (4) Example. The following example illustrates the application of 
this paragraph (e).

    Example. (i) Taxpayer B owns interests in three rental 
buildings, U, V and W. In 1995, B has $30,000 of disallowed passive 
losses allocable to Building U and $10,000 of disallowed passive 
losses allocable to Building V under Sec. 1.469-1(f)(4). In 1996, B 
has $5,000 of net income from Building U, $5,000 of net losses from 
Building V, and $10,000 of net income from Building W. Also in 1996, 
B is a qualifying taxpayer within the meaning of paragraph (c) of 
this section. Each building is treated as a separate activity of B 
under paragraph (e)(1) of this section, unless B makes the election 
under paragraph (g) to treat the three buildings as a single rental 
real estate activity. If the buildings are treated as separate 
activities, material participation is determined separately with 
respect to each building. If B makes the election under paragraph 
(g) to treat the buildings as a single activity, all participation 
relating to the buildings is aggregated in determining whether B 
materially participates in the combined activity.
    (ii) Effective beginning in 1996, B makes the election under 
paragraph (g) to treat the three buildings as a single rental real 
estate activity. B works full-time managing the three buildings and 
thus materially participates in the combined activity in 1996 (even 
if B conducts this management function through a separate entity, 
including a closely held C corporation). Accordingly, the combined 
activity is not a passive activity of B in 1996. Moreover, as a 
result of the election under paragraph (g), disallowed passive 
losses of $40,000 ($30,000+$10,000) are allocated to the combined 
activity. B's net income from the activity for 1996 is $10,000 
($5,000-$5,000+$10,000). This net income is nonpassive income for 
purposes of section 469. However, under section 469(f), the net 
income from a former passive activity may be offset with the 
disallowed passive losses from the same activity. Because Buildings 
U, V and W are treated as one activity for all purposes of section 
469 due to the election under paragraph (g), and this activity is a 
former passive activity under section 469(f), B may offset the 
$10,000 of net income from the buildings with an equal amount of 
disallowed passive losses allocable to the buildings, regardless of 
which buildings produced the income or losses. As a result, B has 
$30,000 ($40,000-$10,000) of disallowed passive losses remaining 
from the buildings after 1996.

    (f) Limited partnership interests in rental real estate 
activities--(1) In general. If a taxpayer elects under paragraph (g) of 
this section to treat all interests in rental real estate as a single 
rental real estate activity, and at least one interest in rental real 
estate is held by the taxpayer as a limited partnership interest 
(within the meaning of Sec. 1.469-5T(e)(3)), the combined rental real 
estate activity will be treated as a limited partnership interest of 
the taxpayer for purposes of determining material participation. 
Accordingly, the taxpayer will not be treated under this section as 
materially participating in the combined rental real estate activity 
unless the taxpayer materially participates in the activity under the 
tests listed in Sec. 1.469-5T(e)(2) (dealing with the tests for 
determining the material participation of a limited partner).
    (2) De minimis exception. If a qualifying taxpayer elects under 
paragraph (g) of this section to treat all interests in rental real 
estate as a single rental real estate activity, and the taxpayer's 
share of gross rental income from all of the taxpayer's limited 
partnership interests in rental real estate is less than ten percent of 
the taxpayer's share of gross rental income from all of the taxpayer's 
interests in rental real estate for the taxable year, paragraph (f)(1) 
of this section does not apply. Thus the taxpayer may determine 
material participation under any of the tests listed in Sec. 1.469-
5T(a) that apply to rental real estate activities.
    (g) Election to treat all interests in rental real estate as a 
single rental real estate activity--(1) In general. A qualifying 
taxpayer may make an election to treat all of the taxpayer's interests 
in rental real estate as a single rental real estate activity. This 
election is binding for the taxable year in which it is made and for 
all future years in which the taxpayer is a qualifying taxpayer under 
paragraph (c) of this section, even if there are intervening years in 
which the taxpayer is not a qualifying taxpayer. The election may be 
made in any year in which the taxpayer is a qualifying taxpayer, and 
the failure to make the election in one year does not preclude the 
taxpayer from making the election in a subsequent year. In years in 
which the taxpayer is not a qualifying taxpayer, the election will not 
have effect and the taxpayer's activities will be those determined 
under Sec. 1.469-4. If there is a material change in the taxpayer's 
facts and circumstances, the taxpayer may revoke the election using the 
procedure described in paragraph (g)(3) of this section.
    (2) Certain changes not material. The fact that an election is less 
advantageous to the taxpayer in a particular taxable year is not, of 
itself, a material change 

[[Page 66501]]
in the taxpayer's facts and circumstances. Similarly, a break in the 
taxpayer's status as a qualifying taxpayer is not, of itself, a 
material change in the taxpayer's facts and circumstances.
    (3) Filing a statement to make or revoke the election. A qualifying 
taxpayer makes the election to treat all interests in rental real 
estate as a single rental real estate activity by filing a statement 
with the taxpayer's original income tax return for the taxable year. 
This statement must contain a declaration that the taxpayer is a 
qualifying taxpayer for the taxable year and is making the election 
pursuant to section 469(c)(7)(A). The taxpayer may make this election 
for any taxable year in which section 469(c)(7) is applicable. A 
taxpayer may revoke the election only in the taxable year in which a 
material change in the taxpayer's facts and circumstances occurs or in 
a subsequent year in which the facts and circumstances remain 
materially changed from those in the taxable year for which the 
election was made. To revoke the election, the taxpayer must file a 
statement with the taxpayer's original income tax return for the year 
of revocation. This statement must contain a declaration that the 
taxpayer is revoking the election under section 469(c)(7)(A) and an 
explanation of the nature of the material change.
    (h) Interests in rental real estate held by certain passthrough 
entities--(1) General rule. Except as provided in paragraph (h)(2) of 
this section, a qualifying taxpayer's interest in rental real estate 
held by a partnership or an S corporation (passthrough entity) is 
treated as a single interest in rental real estate if the passthrough 
entity grouped its rental real estate as one rental activity under 
Sec. 1.469-4(d)(5). If the passthrough entity grouped its rental real 
estate into separate rental activities under Sec. 1.469-4(d)(5), each 
rental real estate activity of the passthrough entity will be treated 
as a separate interest in rental real estate of the qualifying 
taxpayer. However, the qualifying taxpayer may elect under paragraph 
(g) of this section to treat all interests in rental real estate, 
including the rental real estate interests held through passthrough 
entities, as a single rental real estate activity.
    (2) Special rule if a qualifying taxpayer holds a fifty-percent or 
greater interest in a passthrough entity. If a qualifying taxpayer 
owns, directly or indirectly, a fifty-percent or greater interest in 
the capital, profits, or losses of a passthrough entity for a taxable 
year, each interest in rental real estate held by the passthrough 
entity will be treated as a separate interest in rental real estate of 
the qualifying taxpayer, regardless of the passthrough entity's 
grouping of activities under Sec. 1.469-4(d)(5). However, the 
qualifying taxpayer may elect under paragraph (g) of this section to 
treat all interests in rental real estate, including the rental real 
estate interests held through passthrough entities, as a single rental 
real estate activity.
    (3) Special rule for interests held in tiered passthrough entities. 
If a passthrough entity owns a fifty-percent or greater interest in the 
capital, profits, or losses of another passthrough entity for a taxable 
year, each interest in rental real estate held by the lower-tier entity 
will be treated as a separate interest in rental real estate of the 
upper-tier entity, regardless of the lower-tier entity's grouping of 
activities under Sec. 1.469-4(d)(5).
    (i) [Reserved].
    (j) $25,000 offset for rental real estate activities of qualifying 
taxpayers--(1) In general. A qualifying taxpayer's passive losses and 
credits from rental real estate activities (including prior-year 
disallowed passive activity losses and credits from rental real estate 
activities in which the taxpayer materially participates) are allowed 
to the extent permitted under section 469(i). The amount of losses or 
credits allowable under section 469(i) is determined after the rules of 
this section are applied. However, losses allowable by reason of this 
section are not taken into account in determining adjusted gross income 
for purposes of section 469(i)(3).
    (2) Example. The following example illustrates the application of 
this paragraph (j).

    Example. (i) Taxpayer A owns building X and building Y, both 
interests in rental real estate. In 1995, A is a qualifying taxpayer 
within the meaning of paragraph (c) of this section. A does not 
elect to treat X and Y as one activity under section 469(c)(7)(A) 
and paragraph (g) of this section. As a result, X and Y are treated 
as separate activities pursuant to section 469(c)(7)(A)(ii). A 
materially participates in X which has $100,000 of passive losses 
disallowed from prior years and produces $20,000 of losses in 1995. 
A does not materially participate in Y which produces $40,000 of 
income in 1995. A also has $50,000 of income from other nonpassive 
sources in 1995. A otherwise meets the requirements of section 
469(i).
    (ii) Because X is not a passive activity in 1995, the $20,000 of 
losses produced by X in 1995 are nonpassive losses that may be used 
by A to offset part of the $50,000 of nonpassive income. 
Accordingly, A is left with $30,000 ($50,000-$20,000) of nonpassive 
income. In addition, A may use the prior year disallowed passive 
losses of X to offset any income from X and passive income from 
other sources. Therefore, A may offset the $40,000 of passive income 
from Y with $40,000 of passive losses from X.
    (iii) Because A has $60,000 ($100,000-$40,000) of passive losses 
remaining from X and meets all of the requirements of section 
469(i), A may offset up to $25,000 of nonpassive income with passive 
losses from X pursuant to section 469(i). As a result, A has $5,000 
($30,000-$25,000) of nonpassive income remaining and disallowed 
passive losses from X of $35,000 ($60,000-$25,000) in 1995.

    Par. 5. Section 1.469-11 is amended as follows:
    1. Paragraph (a)(2) is amended by removing ``; and'' and adding 
``;'' in its place.
    2. Paragraph (a)(3) is redesignated as paragraph (a)(4) and a new 
paragraph (a)(3) is added.
    3. Paragraph (b)(1) is revised.
    4. The heading for paragraph (b)(2) is revised; the headings for 
paragraphs (b)(2)(i) and (b)(2)(ii) are removed; paragraph (b)(2)(ii) 
is removed, and paragraph (b)(2)(i) is redesignated as paragraph 
(b)(2).
    5. Paragraph (b)(3) is redesignated as paragraph (b)(4).
    6. A new paragraph (b)(3) is added.
    The added and revised provisions read as follows:


Sec. 1.469-11  Effective date and transition rules.

    (a) * * *
    (3) The rules contained in Sec. 1.469-9 apply for taxable years 
beginning on or after January 1, 1995, and to elections made under 
Sec. 1.469-9(g) with returns filed on or after January 1, 1995; and
* * * * *
    (b) * * * (1) Application of 1992 amendments for taxable years 
beginning before October 4, 1994. Except as provided in paragraph 
(b)(2) of this section, for taxable years that end after May 10, 1992, 
and begin before October 4, 1994, a taxpayer may determine tax 
liability in accordance with Project PS-1-89 published at 1992-1 C.B. 
1219 (see Sec. 601.601(d)(2)(ii)(b) of this chapter).
    (2) Additional transition rule for 1992 amendments. * * *
    (3) Fresh starts under consistency rules--(i) Regrouping when tax 
liability is first determined under Project PS-1-89. For the first 
taxable year in which a taxpayer determines its tax liability under 
Project PS-1-89, the taxpayer may regroup its activities without regard 
to the manner in which the activities were grouped in the preceding 
taxable year and must regroup its activities if the grouping in the 
preceding taxable year is inconsistent with the rules of Project PS-1-
89.
    (ii) Regrouping when tax liability is first determined under 
Sec. 1.469-4. For the first taxable year in which a 

[[Page 66502]]
taxpayer determines its tax liability under Sec. 1.469-4, rather than 
under the rules of Project PS-1-89, the taxpayer may regroup its 
activities without regard to the manner in which the activities were 
grouped in the preceding taxable year and must regroup its activities 
if the grouping in the preceding taxable year is inconsistent with the 
rules of Sec. 1.469-4.
    (iii) Regrouping when taxpayer is first subject to section 
469(c)(7). For the first taxable year beginning after December 31, 
1993, a taxpayer may regroup its activities to the extent necessary or 
appropriate to avail itself of the provisions of section 469(c)(7) and 
without regard to the manner in which the activities were grouped in 
the preceding taxable year.
* * * * *
Margaret Milner Richardson,
Commissioner of Internal Revenue.

    Approved: December 12, 1995.
Leslie Samuels,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 95-30872 Filed 12-21-95; 8:45 am]
BILLING CODE 4830-01-U