Electing to aggregate rental real estate activities for real estate professionals

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  1. 1. Electing to aggregate rental real estate activities for realestate professionals.Facts: Pierre Camus is a general partner in the Left Bank Partnership, a real estate managementcompany. He spends around 1,500 hours each year performing personal services for thepartnership. He individually owns six separate rental real estate properties. One of the properties,Cathedral Apartments, produces a $30,000 current loss and has a $100,000 suspended loss. Hespends 100 hours per year managing the complex and is considering selling it. The five otherproperties produce current tax losses of $40,000. He spends 100 hours per year managing each ofthem. In prior years, he has been unable to deduct the losses from these properties, because hisadjusted gross income exceeded $150,000. Pierre has heard of the election available to real estateprofessionals for grouping rental real estate properties. He comes to his tax adviser for advice.Issue: Should Pierre make the election to group his rental real estate properties as provided underSec. 469(c)(7)(A)?AnalysisSec. 469(c)(7) provides that qualifying taxpayers are not required to treat rental activities as passiveper se. To qualify for this special treatment, taxpayers must satisfy two requirements:1. They must perform over 750 hours of personal services in real property trades or businesses inwhich they materially participate; and2. Over half of their personal services must be performed in real property trades or businesses inwhich they materially participate.If these two requirements are met, qualifying taxpayers who materially participate in homes for salemontgomery county md rental real estate activities can treat them as nonpassive.The regulations permit qualifying taxpayers to elect in any year after 1993 to treat all rental realestate activities as a single activity, regardless of how they were treated in prior years. Regs. Sec.1.469-9(g) treats this election as binding for the current year and all future years. The taxpayer canrevoke the election only if a material change occurs in his facts and circumstances. The election toaggregate a taxpayer's rental real estate activities does not affect the determination of whether thetaxpayer materially participates in a limited partnership interest. Taxpayers who adopted rental realestate groupings under Regs. Sec. 1.469-4 should review their groupings.If the election is made, material participation will be determined for the combined activity. Thus,taxpayers will have to determine if they satisfy one of the seven tests for material participation(Temp. Regs. Sec. 1.469-5T(a)) for the rental real estate activity, something they have not done inthe past.Some of the items to consider include the following:1. Does the combined rental real estate activity produce a profit for the taxpayer? If so, and thetaxpayer materially participates, the activity will be treated as nonpassive. Thus, the rental realestate profit will not be available to offset other passive losses.
  2. 2. 2. Does the taxpayer have any suspended losses in the rental real estate properties? If so, thesuspended losses will be treated as losses from a former passive activity. As such, they are carriedforward and are first deducted against profits from the same activity. Any remaining losses continueto be treated as passive losses and are eligible for the special $25,000 rental realty allowance (if thetaxpayer's adjusted gross income is not too high).3. Does the taxpayer intend to dispose of any properties in the near future? If combined, thedisposition probably would not satisfy the disposition of "substantially all" of an activity fordeducting suspended passive losses.In Pierre's situation, it is not clear what the best approach would be. He spends over 750 hours inreal property trades or businesses and over half of his time in such trades or businesses. He is aqualified taxpayer.If he makes the election, he can add the hours from each rental property and determine if he is amaterial participant. He will satisfy the hourly safe harbor test by participating in "the activity" formore than 500 hours during the current year. For Pierre, this means adding 100 hours from each ofsix projects, for a total of 600 hours. He would be a material participant in the real estate rentalactivity: Thus, he could montgomery county md real estate treat the rental real estate losses asnonpassive and deduct the current losses against his other sources of nonpassive income. He coulddeduct $70,000 ($30,000 + $40,000) of the current rental real estate losses as nonpassive losses.However, by making the election, he may notbe able to deduct all of the suspended lossesin the near future. For example, making theelection could slow down Pierre's use ofsuspended losses if he sells the CathedralApartments project. If the election weremade, any suspended losses would remainsuspended in the "combined" rental realestate activity, to the extent they are notabsorbed by gain from the disposition. Suchlosses would be treated as losses from aformer passive activity; they could only bededucted to the extent of income in therental real estate activity.If the election is not made, Pierre will not be able to deduct the current year's losses. However, if theCathedral Apartments project is sold, its suspended loss could be deducted. After the disposition, hecould make the election without fear of limiting his use of suspended losses from the property. Oncemade, the election is binding for the current year and all future years.ConclusionThe relief provision for real estate professionals applies to individuals who spend considerable timein real property trades or businesses and who materially participate in their rental real estateactivities. Thus, it does not provide relief to all real estate professionals. The election to treat allinterests in rental real estate as one activity permits taxpayers to aggregate their hours to satisfy thematerial participation tests.
  3. 3. The benefits of the election (aggregation of hours to become nonpassive) must be weighed againstcertain disadvantages. By not making the election, Pierre could deduct the suspended losses fromone of his properties on its disposition. The likelihood of disposition, the amount of suspended lossand possible gain from the disposition must all be considered when determining if the election isbeneficial. Only after each of these is considered can Pierre make an informed decision.Editor's note: This case study has been adapted from PPC Tax Planning Guide --Partnerships, 13thEdition, by Graver A. Cleveland, James A. Keller, William D. Klein, Terry W. Lovelace, Sara S.McMurrian, Linda A. Markwood and Richard D. Thorsen, published by Practitioners PublishingCompany, Fort Worth, Tex., 1999.Albert B. Ellentuck, Esq. Of Counsel King and Nordlinger, L.L.P. Washington, DCCOPYRIGHT 1999 American Institute of CPA'sNo portion of this article can be reproducedwithout the express written permission from thecopyright holder.Copyright 1999, Gale Group. All rights reserved.Gale Group is a Thomson Corporation Company.