Source: http://www.taxalmanac.org/index.php/Discussion_Real_Estate_Professional_and_the_grouping_of_rental_activities.html
Timestamp: 2020-07-16 00:51:51
Document Index: 502181426

Matched Legal Cases: ['§ 1', '§ 1', '§1', '§1', '§469', '§1', '§1', '§469', '§469', '§469', '§1231', '§1', '§ 1', '§ 469', '§ 469', '§469', '§469', '§469', '§1', '§469', '§469', '§1', '§469', '§469', '§469', '§1', '§1', '§1', '§1', '§469', '§469', '§1', '§1', '§1', '§1']

TaxAlmanac - A free online tax research resource and community - Discussion:Real Estate Professional and the grouping of rental activities TaxAlmanac - Discussion:Real Estate Professional and the grouping of rental activities
Discussion:Real Estate Professional and the grouping of rental activities
Discussion Forum Index --> Tax Questions --> Real Estate Professional and the grouping of rental activities
Isobelmorris (talk|edits) said:
My client qualifies as a real estate professional. She is a full-time realtor and owns several rental properties on ths side. Her losses are above $25,000.
The RE professional box on each SCH E is checked butI get a critical diagnostic stating that to qualify for the full deduction I have to make an election to treat all rental activities as a single activity which I don't want to do. This is not my understanding of the RE Professional rules. Lacerte could offer me no help on this point even when I pointed out that this diagnostic was not around in 2005. Can anyone help me out there? Thanks
I agree. Not passive. Only need to aggregate if trying to meet active participation rules.
I can't help with Lacerte...maybe it's a box that isn't checked someplace on some of the activities...but I agree, it's an election not a requirement.
If you don't make the aggregation election, are you sure that she can satisfy one of the 7 material participation tests on each separate property?
Thank you. I've been wondering why you wouldn't want to make that election?
You generally don't want to make the election because suspended loss is not recognized until there is a disposition of the entire interest.
But, as Riley points out, it is unlikely she will be able to meet the material participation requirements if the properties are not aggregated.
OK, let me think about that. I've got a client with 40-50 properties, we elected to aggregate. He sold some...and the losses on those buildings did pop, so I don't follow...
I disagree, JDUG and Riley, they normally pass test 2
JR, if those losses were suspended passive, the client's election to aggregate did not make it into your computer.
you probably checked the box wrong "did the taxpayer dispose of his entire interest"
So when you aggregrate, and you dispose of a building, you don't catch the suspended losses on that building? That seems odd. That's a good answer then, to why you wouldn't want to do that. . .
EXACTLY!!!! (lets hope the 3 year statute has run on those prior returns everyone realizes they did wrong).
Because the "entire interest" is the ENTIRE ACTIVITY, which is everything they aggregated. Not just 1 property.
The 7 material participation tests are not that easy to satisfy on an individual property basis. I agree that if you have 40 or 50 properties, it is fairly easy to satisfy at least one of the tests if the aggregation election is made.
The one I was referring to that I believe the RE professional COULD pass is: "The taxpayer's participation in the activity for the tax year was substantially all of the participation in the activity of all individuals for the year." Material Participation and Publication 925
I agree with you Kevin...my concern is what is the impact of the final clause "including those individuals who did not own an interest". I guess you have to look through the P&L to determine if there is the possibility that some contractor performed services.
TRUE. Would you consider the time that the tenant mowed his own lawn and changed burned out light bulbs? LOL
section 469(c)(7) states that "rental real estate losses are non-passive if the taxpayer spends more than half his services and more than 750 hours on real property businesses and materially participates in his rentals"
Further " even if a taxpayer is a real estate professional he must still meet material participation for each separate rental before losses will be fully deductible" As for material participation rules you only have to meet 1 of the 7 criteria. I find that most RE Professionals qualify under 2. "The individual is the only one who substantially participates in the activity." (see Kevinh5 comment) The critical diagnostic by Lacerte, I conclude, is misleading. You wouldn't want to group activities for the reasons already described.
Isobelmorris, I do not believe that the average landlord would be able to qualify under the test you cited. This is due to the fact that the landlord would need to refrain from hiring a pool guy, a gardener, a handyman, or any other independent contractor who happens to maintain the property.
The slumlords always qualify. They don't hire anybody to fix anything.
I have a slumlord, Kevin, and they do not lose money....no reason to be a Pro except at qualifying people for Section 8.
Questions regarding nonpassive losses.
How do you know when there is a nonpassive loss? Is it when the losses are greater than any income you have on your 1040. Is there a form that shows that carry forward losses. I know there is the form 8582 for passive losses but what about non passive losses that carry forward?
Also, when you sell the home, you say that those losses carry forward are not deductible on the sale and remain to carry forward until there is income to offset the loss or all of the grouped properties are sold. Does this seem correct?
Nonpassive loss is a loss related to an activity that is not passive, ie a taxpayer's trade/business. It's by each activity, not by the return in total. So if I generate a loss in my business this year, it is nonpassive b/c I materially participate. If you are talking about a rental, the loss is by definition passive unless t/p qualifies under 469(c)(7) as discussed above. Lacerte has a couple of questions for each activity that tell the program if the activity is passive. It does not handle activities where income must be recharacterized to nonpassive very well. Nonpassive losses may carryforward (or back in the case of NOLs) as capital loss carryforwards or net operating losses. If you sell a personal residence at a loss, the loss is personal nondeductible. If you are referring to a property that has been aggregated with other real estate activities as described above, then your last sentence is correct.
thanks for the info. These are for rental properties and there will be a carry forward loss. What form will show if there are nonpassive loss carryforwards (1045) for the rental losses for a real estate professional??? I understand the answer for question 2.
I'm not sure I understand - it seems that you have answered your own question. If you have losses in an activity that is not passive, then it is a net operating loss. You calculate that on the workpaper on Form 1045. It is not necessarily the # on the tax return because there are adjustments for nonbusiness income/deductions among others. If you want to carry the loss forward, don't forget to elect to forego the carryback period.
Might consider putting the properties into a LLC management group. Then all properties are grouped for material participation purposes, some limited liability may exist (see your attorney) and the property may be sold (any suspended losses released). For real estate professional, NOL may be generated offseting ordinary income and is subject to carryback and forwards.
Warning: Profits by real estate professionals may be taxed as earned income. Restructuring the investment may be easier if an LLC is used.
Sounds good. I plan to help her set up all of her properties in an LLC this year.
When you group all of the properties in an LLC, you can still do seperate Schedule Es correct?
Not schedule E's. Maybe you should see a tax professional.
If they are single owner LLCs, owned by a natural person, then YES, Sch E.
MarkO (talk|edits) said:
Going back to whether or not to aggregate the activity...
I'm running into this issue as well, that the TP would not make the hours requirement because he owns 3 props, unless I aggregate them. Now, it was mentioned above (February posts) that you wouldn't want to aggregate because you would need to dispose of the entire activity to free the losses, not just a single property. My queston is, if you're a R/E pro, what suspended lossses would you have if all losses flow out each year? There seems to be no downside, which is giving me reason to pause and pose this questions. Am I missing something? Any insight would be appreciated.
1) prior suspended losses retain their character
2) What if he quits real estate?
Mark, there's a case, Jahina. The case is an easy read. I am writing this based upon my memory of some work I did a couple of years ago, so forgive me if I'm off a bit. The commentary on it was that if the t/p was trying to qualify under 469(c)(7) based upon a rental activity alone, he would have to qualify with respect to each rental activity, and that doesn't work with the more than 50% rule. If that's correct, and you are trying to qualify as R/E pro based upon rentals (instead of for example real estate development), then I don't think you have a choice. If you don't aggregate, if my memory re this case is correct, he's not going to qualify with regards to 2 of the 3 properties.
If he quits real estate, then you are no longer under 469(c)(7), and as I understand it, that election to aggregate no longer applies. Point here is that if at a later date you need these activities separated, I think all he has to do is fail 469(c)(7) in that year.
And I completely see your point. If all is aggregated, all losses flow out anyway, therefore there are no suspended losses, so what's at risk in making the election. Your thought process seems correct to me, and next time I am dealing with this issue, I am going to remember what you said.
But again, all of above is just based upon the memory of research done a while ago. You wouldn't make any decisions without checking out the thoughts presented in this casual conversation, right?
JimEL3 (talk|edits) said:
I am working with a TP who owns rental property with 2 other partners. They have set up as an LLC but do not have the property in the name of the LLC. (Another discussion all together) The property is in the personal name of 3 partners. However, they are running all income and property expenses through the LLC's bank account. The 2 other partners are running the real estate activity through Schedule E, I feel it is better to run all expenses through LLC return and then distribute K-1's. Is there an issue with property not being in the LLC's name where this would be a problem? Additionally, I think the active participation rule would apply as combined, all 3 spend more than 750 hours but am I thinking about this incorrectly?
no liability protection the way they are doing it, but I'm sure the attorney told them the LLC was good for much more.
a non-tax-pro question and related posts from 2008 have been moved here.
Yes, I too have been making the RE professional election for several real property owner clients of mine. Mainly because of the argument I read in this thread - so what if suspended losses cannot be released unless ALL properties are disposed of. THERE SHOULDN'T BE ANY SUSPENDED LOSSES. If there were suspended losses before the election was made - well then you have something to think about.
I especially liked the comments about when a RE professional quits being one. Well, fine, so be it. Back to the $25000 per year rules.
Some comments in this thread about putting all RE properties into one LLC concerns me. I have been taught that you would NEVER do this. The object of the LLC is limiting liability exposure to the assets of the LLC. You only want ONE property in any ONE LLC. If you have three properties in one LLC, then the equity IN EACH OF THE THREE PROPERTIES is available to the liars, I mean lawyers, suing you.
Anyone advising clients to combine multiple properties in ONE LLC should think about this. Some of the comments in this thread suggested that some professionals may be advising their clients to do this.
One reason to not make the election is if you have a property generating passive income. If you can qualify as a RE professional and show material participation in most or all of the loss activities and maintain the passive status of the income, then you have a nice income source to offset any passive losses.
If you elect to aggregate and then fail to qualify as a RE professional, I don't know if the activities remain aggregated or if they become segregated. On the one hand, the taxpayer is no longer a RE professional, so you would think that the election made under that provision shouldn't matter. On the other hand, you've essentially chosen how you are going to group your activities, and there is a reg that requires consistency in how you group those activities.
Under Reg § 1.469-9(g)(1), the aggregation election is not effective in those years in which the taxpayer is not a real estate professional.
Regarding the LLC vs non LLC for rental properties (really a separate discussion!) I think that the real question is one of liability and not tax treatment. If you have a smllc with a rental, you file schE but if you are like most cheapo landlords you do most of the work yourself. Hence you are exposing yourself to liability regardless because the LLC limits the liabilty to your own acts. The key is to have excellent insurance! Also - make sure all of those working on the property (if anyone is hired) is also insured. Do not have a friends & family fix-up party! I have only a few clients that really put the rental in the LLC as was intended. Myself included, I kept vacillating on whether or not it made sense.
I think that one of the downsides of grouping is as follows: Say the taxpayer owns 6 properties and has never made the election to group until 2008 and has incorrectly passed through 100% of the losses over the years. If the IRS comes in to reclassify these losses as passive, i.e. did not meet material participation on each property, then it seems to me, not only are there going to be back taxes, penalties, and interest on the prior years, but since the activities are now grouped, the taxpayer is going to be stuck with these now former suspended passive losses which can only be utilized later when there is income from the new grouped activity or until a total disposition of the entire activity. So , the taxpayer would not even benefit from selling one or two properties to pay the old taxes if he needs to since he is stuck with the suspended losses tied to a new grouped activity.
Dearest Kevin ... please elaborate on how my thinking is flawed .....other than the fact that he may still benefit from selling a property to get the cash out to pay the tax !!
1) If the taxpayer has been improperly taking losses then he deserves to pay back taxes, interest and penalties. Most people follow the rules and laws of their society, those that don't deserve to pay the price for non-complance. I have no sympathy for ignorance when there are so many competent professionals out there willing to help a person keep in the good graces of his government.
2) Since the taxpayer did not group the activities in the past, there will be no problem with their grouping unless and until the taxpayer makes a decision to group them. This should not be done without the help of a competent paid professional.
3) "since the activities are now grouped..." Where? When? Why? Your scenerio doesn't show that they need to be or ever were grouped until now.
4) Even if the activies were grouped, in the event of a disposition of one of the properties/sub-activities (but not a full disposition of the entire group/activity), any gain from that disposition would free up an equal amount of previously unallowed losses. The only thing missing is the ability to currently deduct losses in excess of gains. But, until the last two years, how many times has THAT really been a problem? Statistically, it used to happen so rarely that it was only a hypothetical textbook example.
5) 'So, the taxpayer would not even benefit from selling one or two properties to pay the old taxes..." WHAT OLD taxes? There are no 'OLD' taxes. There is only suspended loss. The 'old taxes' have been paid. Or rather, should have been if the taxpayer had been complying with the tax laws correctly
5) cont'd. Oh, I get it. He screwed up and grouped now going forward. Yup, he screwed up. Before and now. E&O anyone? see my post above from feb 13, 2007.
Now I think by 'old taxes' you mean what he got caught cheating the rest of us citizens out of by filing a return claiming improper losses.  Yes, he can still raise cash by selling, or borrowing, as he should to pay his rightful tax bill.
(and don't we all wonder why any 'professional' would want to own 6 LOSING properties?)
so maybe if that's what you mean, then maybe your thinking isn't flawed, at all
but then again if the statute of limitations has run (remember he has a longer statute if the omitted income was over 25% of that required to be shown) this is all just conjecture and posturizing. Was he caught?
I thought I had replied but it looks like it did not save.
Point 1: Honestly, I reviewed one tax return the other day where the T/P owns 10 properties and the prior preparer put the depreciation for all properties on Property #1. Guess what? IRS is auditing the return. Wonder why ???
Other points: Taxpayer did not group until 2008. Went to a seminar which recommended the grouping activity, and so grouped them in 2008. Then asked me my opinion about it.
My thinking above was that if IRS came in and disallowed the prior year losses, i.e. now taxpayer has prior suspended activities, that if the rentals are grouped that UNLESS there is income generated by the group in the form of either rental income or sale of a property, that the suspended losses would remain just that -- as suspended. In this real estate market, I don't know how much income will get generated ..... but to the points above where some stated that there would be no suspended losses to worry about .... that would only be true if you started the grouping from Day 1. In this client's case, not necessarily so.
You are right...by "old taxes" I meant the ones that he may now get caught on -- I mean IRS is hot now on the topic of deducting losses in excess of the $25K ...
He has not been "caught" yet.
Please clarify one more point for me. I thought that once the rentals were grouped that the suspended losses (if any) would not be freed up until the entire activity was disposed of, notwithstanding income generated within the group per 469(g). Kevin stated above in Point 4 that "Even if the activies were grouped, in the event of a disposition of one of the properties/sub-activities (but not a full disposition of the entire group/activity), any gain from that disposition would free up an equal amount of previously unallowed losses."
If the rentals are all grouped then seems to me the entire disposition would mean all of the properties......the downside I was trying to get to was that if IRS disallowed this guy's losses, and now he has grouped them, that even if he sold a property within the group, that the suspended losses would not be freed up since that property is now part of a group and disposing of one property within the group does not make for an entire disposition of the activity.
You can dust off the old disqualifying-home-office-in-year-of-sale strategy and advise your client to spend no more than 499 hours managing his combined rental group in the year of sale.
I agree with Kevin regarding the partial sale of a former passive activity. Although, PPC does not.
if the sale of one property inside the group generates a gain, that gain is passive gain. This isn't a publicly traded partnership, and neither are the former passive losses (from each property before they were grouped). Therefore the net passive gain (which might be 1231 gain or 1250 gain or even 1245 gain, or for that matter, even ordinary gain) can be offset with suspended former passive losses up to the amount of the passive gain.
I know this passive stuff is advanced tax law, but I think that the above explanation is basic knowledge for the passive topic. It is one of the first things you learn when you learn passive.
I think, Chase, that what you are getting hung up about is the losses inside the group. In the example I give above, there is a gain from the disposition of one property. That gain first offsets current then suspended losses from the group (if any). If there is still a positive net gain, that gain is passive, and can be used against current and suspended losses from outside of the group (except for those created by publicly traded partnerships).
then 'voila' we agree, there is no problem with selling one or two properties.
Now let me take that one step further to show you the problem of which you speak/write:
Suppose there was no gain further than that absorbed by the group. Then, the loss from all of the former passive activities (individual properties) still sits there. Therefore, the 'books'/return will still track suspended losses from a property which the taxpayer no longer owns.
Thus the problem way above in this thread.
Voila -- that makes sense! Wiles is right above...in that PPC does not explain it this way in my opinion. Kevin, thanks for taking that one step further.
I don't have PPC so I have never seen how they explain it.
Riley stated in an earlier post, "Under Reg § 1.469-9(g)(1), the aggregation election is not effective in those years in which the taxpayer is not a real estate professional."
However, if the taxpayer IS a real esate professional (e.g. works full time in construction), makes the election to aggregate his rental properties, and, then, later (at audit) the IRS determines that he fails all 7 material participation tests on his aggregated rental properties, then taxpayer is still stuck with election. Right?
If taxpayer is over $150K AGI, and disposes of one of the properties at a loss in the year under audit, then that loss is suspended. Taxpayer = Screwed. Correct?
Therefore, it may be wise to NOT include any SOLD properties in the election during the year of sale. Assuming, of course, that the taxpayer would still qualify for material participation in the remaining aggregated properties.
I have a new question that is related to this discussion. If a taxpayer has elected to group their rental real estate activities, but later it is determined that she does not meet the material participation rules. And in that year one of the rental properties was sold at a loss, then what happens with the loss on that sale?
Forget about any suspended losses or any current year operating losses on that property. I am only asking about the loss on that sale. Does she get the full loss from that sale? Or is it limited to the $25,000?
Assuming that the taxpayer is not a qualifying individual, the aggregation election has no effect in this case. See 1.469-9(g). The loss would be allowed in full.
On the other hand, if she is a qualifying individual, then the aggregation election would force her to limit her losses to $25,000.
Thanks, R2. That is great news. Let me paraphrase to see if I understand. Since the taxpayer does not meet the material participation rules, then she is not a qualifying taxpayer per Reg §1.469-9(c)(3). And since she is not a qualifying taxpayer, then the election is not binding per Reg §1.469-9(g)(1).
So in the case where they fail the material participation rules under audit, then the election to aggregrate for that year is, in effect, void.
Wiles, the $25,000 allowance for rental real estate losses, which is phased out as AGI increases from $100,000 to $150,000, is for operating losses and has nothing to do with a loss from the sale. See IRC §469(i)(1). So, there is no $25,000 limitation on the loss that a taxpayer sustains from the sale of rental property in which she does not materially participate.
Now, if your question is whether a taxpayer who previously qualified as a real estate professional, and while qualifying, made an election to treat all interests in rental real estate as a single activity, but who does not satisfy the material participation rules for the the current year, is entitled to deduct the loss from the sale of one property, my answer is "it depends."
Are you saying that in the current year, the taxpayer doesn't qualify as a real estate professional? In relevant part, Treas. Reg. §1.469-9(g)(1) states, "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 section 1.469-4." In other words, if, in the current year, the taxpayer doesn't qualify as a real estate professional, then the aggregation election is not in effect, and the sale of one or more rental properties at a loss will be allowed.
In the year of sale, she does qualify as a real estate professional based on activities in a separate construction business. In prior years and the current year, she elected to aggregate her rental real estate because she felt she did meet material partipation on those properties. However, under audit, it is determined that she did not meet the material participation rules with respect to the aggregated rental real estate.
So what happens now to the loss on the sale of one of those properties in the current year?
The $25,000 limitation on losses would apply to the sale if the aggregation election was made and the taxpayer was a qualifying individual during the year of the sale. My answer would change if the taxpayer sold all her rental properties in a single year.
For example, if we assume that Wiles's client is a full-time real estate broker, then she is a qualifying individual and the aggregation election would operate to limit her loss to $25,000. In other words, IRC 469(g) would not allow her treat the loss as a non-passive loss since there was not a complete disposition. This would be true even if the taxpayer received no tax benefit from the aggregation election.
The million dollar question -- was she in the construction business in the year of the aggregation election?
Yes. She was in the construction business in the year of sale.
I misread Reg §1.469-9(c)(3). I thought this dealt with whether or not she met the material participation test with respect to the rental properties alone.
"The $25,000 limitation on losses would apply to the sale"
R2, I think you're misreading the statute. The $25,000 limitation (IRC §469(i)) doesn't apply to losses from a sale, but rather, to operating losses. IRC §469(i) specifically refers to a "passive activity loss," and IRC §469(d)(1) defines a "passive activity loss" as the excess of passive activity losses over passive activity income for the year. A loss from the sale of rental property is a loss under IRC §1231, and is not a "passive activity loss" for the year.
Wiles, if the taxpayer qualifies as a real estate professional for the current year, then the election to treat all interests in rental real estate as a single activity remains in effect, and the loss from the sale of one or more rental properties in the aggregated group is not allowed. See the following excerpt from Treas. Reg. §1.469-9(g)(1):
"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." [emphasis added]
But that's not fair! :)
"A loss from the sale of rental property ... is not a "passive activity loss" for the year."
DaveF, you may be making a distinction between "operating" passive losses and "disposition" passive losses that doesn't exist. The IRC doesn't seem to address this directly, but there is a regulation - Reg § 1.469-2T(d)(5) I think - that says this about that:
(5) Treatment of loss from disposition —(i) In general. Except as otherwise provided in the regulations under section 469—
How does this Regulation square with Sec. 469(g)(1)(A). (I realize this section speaks of the excess of loss over gain)
the problem, Harry, is that if the grouping election is effective for the year, the sale of one property is not the complete disposition (in a fully taxable event) of the entire activity.
Agree with Harry. The cited regulation is right on point.
A loss from the disposition is covered under Sec. 469(a), and therefore Sec. 469(i).
Internal Revenue Code § 469(i) applies to any loss that would otherwise be disallowed under Internal Revenue Code § 469(a).
Harry and R2, what you are saying is that if a taxpayer sells a rental property for more than a $25,000 loss, the loss on the sale is limited, i.e., the portion that exceeds $25,000 is not deductible, and if AGI is more than $150,000, then none of the loss on the sale is deductible. You are incorrect.
The $25,000 limitation in IRC §469(i) applies to rental real estate activities, which are automatically treated as passive under IRC §469(c)(2). IRC §469(g)(1) provides that the loss from the disposition of a passive activity in a fully-taxable transaction, to the extent that it exceeds passive income, "shall be treated as a loss which is not from a passive activity." In other words, such a loss is treated as nonpassive. Treas. Reg. §1.469-2T(d)(5) does not override IRC §469(g)(1).
What is the definition of activity? If activities are aggregated, is it now just one activity with many "subactivities"? And the sale of a subactivity can only be treated as a partial disposition.
Dave, you cannot use 469(g) unless there is a disposition of the taxpayer's entire interest in the property. In the fact pattern given, only a small portion of the taxpayer's entire interest in the "property" was sold. Remember that the taxpayer is treating all of her rental properties as a single property.
My answer would change if the taxpayer revokes her aggregation election. In order to revoke the election, she would need to demonstrate a change in facts and circumstances.
We've already seen these "facts and circumstances" come up over the last 24 hours, and it's always bad.
"Harry and R2, what you are saying is that if a taxpayer sells a rental property for more than a $25,000 loss, the loss on the sale is limited, i.e., the portion that exceeds $25,000 is not deductible, and if AGI is more than $150,000, then none of the loss on the sale is deductible."
Yes, if I *had* said that, I *would have been* incorrect. But, that's not what I said.
R2, none of your comments (or Harry's) addressed the specific facts and circumstances, but rather, were comments about the law, and therefore, since they were incorrect, I was pointing this out.
Sorry about that. I was only responding to Wiles's fact pattern.
Somewhere late in the thread, Wiles mentioned that the aggregation election was made while the taxpayer was a full-time construction contractor and that only one dwelling unit out of many was sold.
Brian13 (talk|edits) said:
Okay, now i'm dealing with this issue. I have a client who elected to aggregate his rental operations. He has one big loser and he is selling it. It's going to create a substantial losss on the sale. Is this loss limited?
I've read and read and read and there are no clear answers. I understand the drawback of aggregating that doesn't allow you to use pre-aggregation losses when a property is sold, but what about the loss on the sale?
Are you referring to the aggregation election for real estate professionals under IRC §469(c)(7)(A), or the grouping election under Treas. Reg. §1.469-4(c)?
The aggregation election.
The loss is not limited.
Under IRC §469(c)(1), a passive activity is defined as a business activity in which the taxpayer does not materially participate. Under section 469(c)(2), a rental activity is automatically classified as a passive activity. But there’s an exception.
Under IRC §469(c)(7)(A)(i), if the taxpayer qualifies as a real estate professional, then the automatic classification of a rental activity as passive doesn’t apply to any interest in rental real estate. In addition, under IRC §469(c)(7)(A)(ii), if the taxpayer qualifies as a real estate professional, then each interest in rental real estate (e.g. a property) is treated as a separate activity unless the taxpayer makes the election to treat all interests in rental real estate, in the aggregate, as one activity.
So, if an individual qualifies as a real estate professional and makes the "aggregation" election, then all of the individual’s real estate rentals (properties) are treated as a single activity, and as long as the individual materially participates in the overall activity, then the activity won’t be treated as a passive activity.
Some practitioners have told their clients who qualify as real estate professionals that if they make the "aggregation" election to treat all of their rental properties as a single activity, then they won’t be able to deduct a loss on the sale or other disposition of only one of the rental properties in the "group."
In addition, the IRS says this on page 5-2 of its Audit Technique Guide for Passive Activity Losses:
"If the taxpayer made an election to group his rentals as a single activity under Reg. §1.469-9(g) [the aggregation election for real estate professionals], the sale of one property would not constitute an entire disposition."
The IRS's Guide is wrong on this point. I was wrong on this point as well, but after further research, I believe that the loss is allowed.
Apparently, the IRS is applying the rule in Treas. Reg. §1.469-2T(d)(5) and in the example in Notice 2008-64, 2008-31 I.R.B. 268 to a real estate professional who makes the aggregation election. This rule applies only to the grouping election made under Treas. Reg. §1.469-4.
In addition, this rule applies to a disposition of an interest in a passive activity. If an individual qualifies as a real estate professional, has made the "aggregation" election, and has materially participated in the aggregated interests in rental real estate, then none of the individual’s interests in rental properties is treated as interests in a passive activity. Accordingly, Treas. Reg. §1.469-2T(d)(5) doesn’t apply since it applies only to an interest in a passive activity. As a result, such a real estate professional is entitled to deduct the losses on the disposition of one of the aggregated interests in rental real estate.
No wonder you said that there are no clear answers. I hope that this has cleared it up.
Dave, thank you for that clarification. That always bugged me, seemed to say - treat as nonpassive until you sell it, then treat it as passive.
Thanks for that thorough ecplanation Dave. It sure helped me out.
I was provided with a Journal of Accountancy article from Feb 2008. On this issue the article seems to agree with the IRS:
Real Tax Savings in Real Estate - JOA 2008.htm
But I don't think that passes the common sense test. I'm still looking to find a tax court case on the issue.
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I'm aware that in the Murphy & Gunter article, the authors reached the same conclusion that the IRS did in its Audit Technique Guide, but I think that their conclusion is wrong as I have explained above. I've sent an email to Murphy & Gunter asking them to reconsider what they said in the article. I'll post their reply here.
I'm not aware of any court cases that have dealt with this issue.
Thanks for the response Dave. I appreciate your input.
What is the difference between the aggregation election and the grouping election?
The aggregation election of IRC §469(c)(7)(A) is made by a person who qualifies as a real estate professional under IRC §469(c)(7)(B). See Treas. Reg. §1.469-9(g).
The grouping election is made by a person who does not qualify as a real estate professional and its purpose is to group one or more passive activities together. See Treas. Reg. §1.469-4(c).
Another great analysis, Dave. I have a folder on my desk with a lot of your stuff in it. Keep it up.
Maybe the JOA article is saying (1) That we don't have a complete disposition here and (2) As a result, suspended passive losses produced in years prior to the year in which the aggregation election was made will not be freed up.
Note that the complete disposition rule of 469(g) applies to passive activities AND former passive activities.
(Perhaps the JOA authors are confusing (1) loss on disposition with (2) previously suspended passive losses).
Similarly, if one of the aggregated properties were to be sold for a gain, the gain would be non-passive, and therefore, may not completely free up previously suspended passive losses. I believe this non-passive gain, which is derived from a now non-passive activity and also a "former passive activity," would only free-up previously suspended passive losses to the extent of the gain.
Two Headed Mule (talk|edits) said:
Assume an aggregation election is in effect under -9(g) for a number of rental properties and that there are suspended passive losses from prior years attributable to a rental property that is now sold. The treatment of the sale depends upon several factors, including: whether the taxpayer qualified as a REP in the year of sale; whether, if the taxpayer qualified as a REP in the year of sale, he also materially participated in the combined activity in the year of sale; and, if the taxpayer did not qualify as a REP in the year of sale, he made (or did not make) the grouping election under -4.
If in the year of sale the taxpayer qualifies as a REP and materially participates in the aggregated activity, then the gain/loss from the disposition of the one property will be nonpassive. However, prior year suspended passive losses attributable to the sold activity will not necessarily be freed entirely because the entire activity (now encompassing the aggregated activities) will not have been disposed of. Those losses can be freed only to the extent of the net income of the combined activity under the former passive activity rules.
If in the year of sale the taxpayer qualifies as a REP but does not materially participate in the aggregated activity, then the gain/loss from the disposition will be passive. The sale will release suspended losses to the extent of ALL of the taxpayer's passive income (not just those of the combined activity since the former passive loss rules do not apply).
If in the year of sale the taxpayer does not qualify as a REP, then the answer depends upon whether the taxpayer elected to group under the -4 rules. If no grouping decision was made, then 469(g) applies and suspended passive losses are freed (passive to the extent of gains from all passive activities, nonpassive to the extent of the excess). If a grouping election were made under -4 then 469(g) likely doesn't apply. Gain or loss on the disposition is passive and suspended passive losses are freed only to the extent of all passive income.
"As a result, such a real estate professional is entitled to deduct the losses on the disposition of one of the aggregated interests in rental real estate."
Dave, do I read this to mean pre-election passive losses (for there should be no post-election priorlosses) in addition to the loss on sale? Or is Two Headed Mule's second paragraph correct?
Reading Dave's comment carefully, I am taking it to mean the loss on disposition, not all prior passive losses on the property.
D&T, I meant the loss on disposition, which would not be allowed if the taxpayer did not qualify as a real estate professional and elected to group the passive activities under Treas. Reg. §1.469-4(c).
I don't fully agree with Two Headed Mule's second paragraph. I agree with the statement, "If in the year of sale the taxpayer qualifies as a REP and materially participates in the aggregated activity, then the gain/loss from the disposition of the one property will be nonpassive." But whether passive losses from prior years that were suspended prior to the time that the taxpayer became a real estate professional and prior to the time that the taxpayer made the aggregation election under Treas. Reg. §1.469-9(g) are allowed depends upon whether the taxpayer has other passive income against which to claim those suspended losses. I don't think that it has anything to do with whether the entire activity is disposed of.
My word, so pleased/sad to see so many interested in this subject. I'm in middle of yet another audit of a REP. I've read IRS is really going after returns with these on them. I believe it.
RE taking loss on a property part of an agregation. I literally, just did an audit in which was a property included in the agregate, was sold at a loss. Tas preparer of the return had taken this loss, complete disposition of this property, in the audit, IRS allowed the loss.
One of the first responses referred to passive losses. If taxpayer qualifies as a REP, from my experience, agregating is 99% of the time, best avenue.
However, taxpayer will have to prove, 1-over 750 hours of material participation for all entities. 2- over 50% of all personal services time is REP time.
Selling one property out of an agregate not a problem. (Two headed Mule, is way more detailed than I and is totally correct). You can sell or dispose of one out of agregate, basically, take profit or loss it on return.
Thanks Dave, Grouping and Agregating, gotta read up on this. It's efects. Hmmm
We have Ultra tax, to agregate is an election.
Oh, FYI, this has been mentioned several times here. If you have not read the audit guide on passive losses, do! Go to IRS.com, type in 'audit guide passive losses', or passive loss guide, print and read every page. This is a NEED TO KNOW!! Thanks for providing some very interesting reading.
Laura6 (talk|edits) said:
This is the first year I have had to deal with passive/non-passive income for rental properties. However, after reading through the tax code and this forum, I have concluded as follows (please clarify or correct if necessary):
Situation: S-Corp purchased and owns 3 rental properties and is in the business of managing and renovating them as well as searching for new properties on an ongoing basis for real estate speculation and rental income. All properties were purchased in the same tax year in which the election to aggregate was made.
My understanding: If there are no former suspended losses from prior year purchases of rental property, all properties aggregated will have losses flow through the pass through entity as aggregated property (if the election is made in the tax year). Once the sale is made in a later year, because there are no former suspended losses prior to the election, any gain/loss is considered as typical in a real estate gain/loss. Further, any 50% (or more) corporate owners must also elect to aggregate any income from the rentals on their individual tax return to reap the benefits of non-passive RE professional income of the property elected to be aggregated on the S Corp return.
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