Discussion:Real Estate Professional and the grouping of rental activities

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

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"

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.

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?

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.

Warning: Profits by real estate professionals may be taxed as earned income. Restructuring the investment may be easier if an LLC is used.

When you group all of the properties in an LLC, you can still do seperate Schedule Es correct?

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.

2) What if he quits real estate?

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.

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.

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.

Is my thinking flawed?

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

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?)

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.

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.

I agree with Kevin regarding the partial sale of a former passive activity. Although, PPC does not.

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.

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.

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.

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?

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.

So what happens now to the loss on the sale of one of those properties in the current 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.

See my post immediately above.

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.

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]

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—

(A) Any loss recognized in any year upon the sale, exchange, or other disposition (a “disposition”) of an interest in property used in an activity at the time of the disposition or of an interest in an activity held through a partnership or S corporation and any deduction allowed on account of the abandonment or worthlessness of such an interest is treated as a deduction from such activity; and

(B) Any such deduction is a passive activity deduction if and only if the activity is a passive activity of the taxpayer for the taxable year of the disposition (or other event giving rise to the deduction).

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).

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).

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.

Yes, if I *had* said that, I *would have been* incorrect. But, that's not what I said.

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.

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?

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.

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 not aware of any court cases that have dealt with this issue.

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).

Bob

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.

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.

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.

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.

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.

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.

Is this correct?