The election to aggregate all rental real estate interests is a tax strategy used by some real estate professionals. Find additional details about when to use this election -- and when it may not be the best idea -- below.
For purposes of the rule exempting rental real estate activities of real estate professionals from automatic treatment as passive activities, a taxpayer may elect to treat all interests in rental real estate as one activity.
“ Example: John owns interests in three rental buildings, X, Y and Z. He elects to treat the three buildings as a single rental real estate activity. Therefore, in determining whether John’s activities with respect to these buildings are passive or nonpassive, John's activities and participation with respect to all three buildings are taken into account in the aggregate. ”
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The election is made by filing a statement with the taxpayer's original income tax return for the tax year. This statement must contain a declaration that the taxpayer is a qualifying taxpayer for the tax year and is making the election under Code Sec. 469(c)(7)(A).
The election may be made in any year in which the taxpayer is a qualifying taxpayer. The failure to make the election in one year doesn't bar the taxpayer from making the election in a later year.
This election is binding for the tax year in which it's made and for all future years in which the taxpayer is a qualifying taxpayer, even if there are intervening years in which the taxpayer isn't a qualifying taxpayer. The election won't have effect in years during which the taxpayer isn't a qualifying taxpayer. Instead, the taxpayer's activities will be those determined under “grouping of activity” rules of Reg § 1.469-4.
No valid election was made where a taxpayer failed to attach an election statement to his return. To make an election, a taxpayer must clearly notify IRS of his intent to do so. (Kosonen, Matti, (2000) TC Memo 2000-107)
Real estate professionals who follow procedures announced by the IRS in Rev Proc 2011-34 will be eligible for an extension of time to file the election to aggregate real estate interests as a single activity, without having to apply for a private letter ruling or pay a user fee. To be eligible, the taxpayer must provide a statement, attached to an amended return for the most recent tax year and signed under penalties of perjury (see the Rev Proc for the required wording), stating that he or she:
Had failed to make the election only because the election would not have been timely;, Had filed returns consistent with having made an election and aggregating the activities;Had timely filed (within 6 months of the due date, excluding extensions) each return that would have been affected by the election if it had been timely made; and,
Has reasonable cause for not making a timely election.,The reason for failing to make a timely election must be explained, and must contain the declaration required by § 1.469-9(g)(3), including the year for which the late election is being made. At the top of the statement, note “FILED PURSUANT TO REV. PROC. 2011-34.” Mail the amended return to the IRS Service Center where the taxpayer’s current year return will be filed.
The IRS will notify the taxpayer if their request for extension to make the election is granted. A taxpayer receiving relief under this revenue procedure is treated as having made a timely election to treat all interests in rental real estate as a single rental real estate activity as of the taxable year for which the late election was requested.
The election may be revoked if there is a material change in the taxpayer’s facts and circumstances. The fact that an election is less advantageous to the taxpayer in a particular year is not, of itself, a material change 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.
The election may be revoked 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 election year. To revoke the election, the taxpayer must file a statement with his or her original income tax return for the year of revocation containing (1) a declaration that the election is revoked under section 469(c)(7)(A) and (2) an explanation of the nature of the material change.
Electing to treat all a taxpayer's rental real estate activities as a single activity may make it easier to meet the material participation requirement (resulting in treatment of the rental real estate activities as nonpassive).
It may not be advisable for a taxpayer to make the election to aggregate all rental real estate interests if he has positive net income from rental real estate activities and passive losses from activities other than rental real estate activities. In that case, treating the rental real estate activities as passive would be advantageous, because the taxpayer could use the losses from the other passive activities to offset the income from the rental real estate activities. But if, under these circumstances, the taxpayer made the election to aggregate all rental real estate interests, the rental real estate activities might not be treated as passive, in which case the passive losses from the non-rental real estate activities could not be used to offset the income from the rental real estate activities, and might even be suspended and thus not deductible at all until the taxpayer disposes of the entire activity.
Real estate professionals that make the aggregation election may use prior year disallowed passive losses from any of the rental real estate activities that the taxpayer has elected to aggregate, to offset current net income from the aggregated rental real estate activities, regardless of which rental real estate interests within the aggregated activity produced the income or prior-year losses. Moreover, this rule applies even if the disallowed prior year losses arose before the aggregation election was made.
“ Example: The facts are the same as the previous example above. In Year 1, John has $30,000 of disallowed passive losses allocable to building X and $10,000 of disallowed passive losses allocable to building Y. In Year 2, John has $5,000 of net income from building X, $5,000 of net loss from building Y, and $10,000 of net income from building Z. John makes the election to treat the three buildings as a single rental real estate activity effective in Year 2. In that year, John participates in the operation of the three buildings for more than 500 hours. He thus materially participates in the combined activity making the combined activity a nonpassive activity. ”
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A passive activity is any activity:
That involves the conduct of any trade or business, and In which the taxpayer does not materially participate.“ Because of the election, disallowed passive losses from Year 1 of $40,000 ($30,000 plus $10,000) are allocated to the combined activity. John’s net income from the activity for Year 2 is $10,000 ($5,000 – $5,000 + $10,000). This net income is nonpassive income. Under Code Sec. 469(f), the net income from a former passive activity may be offset with the disallowed passive losses from the same activity. As a result, John 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, leaving zero net income from the buildings in Year 2. Moreover, John has $30,000 ($40,000 – $10,000) of disallowed passive losses remaining from the buildings after Year 2. ”
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The election to aggregate all rental real estate interests isn't intended to alter the rules relating to the material participation of a limited partner. (H Rept No. 103-111 (PL 103-66) p. 614)
If a taxpayer makes the election 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, the combined rental real estate activity is treated as a limited partnership interest of the taxpayer for purposes of determining material participation. Accordingly, the taxpayer won't be treated as materially participating in the combined rental real estate activity unless the taxpayer satisfies one of the material participation tests allowed to limited partners explained above. (Reg § 1.469-9(f)(1))
If a real estate professional makes the election to treat all interests in rental real estate activities 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 10% of the taxpayer's share of gross rental income from all of the taxpayer's interests in rental real estate for the tax year, the taxpayer may determine material participation under any of the tests that apply to rental real estate activities.
Under Sec 199A for years 2018 through 2025 taxpayers are allowed a deduction of 20% of qualified business income (or 20% of the individual’s taxable income, if less) from pass-through activities, including Schedule E rentals.
One of the many issues related to the Sec 199A deduction that was raised is whether the same grouping of activities will apply for the Sec 199A computation that is elected for purposes of exempting a qualified real estate professional from the automatic treatment of rentals as passive activities.
The answer is NO. In final Reg. 1.199A-4, the IRS says that aggregation is permitted but not required and sets forth the requirements for establishing Sec 199A groupings. The preamble to the final regulations says “The Treasury Department and the IRS do not consider the grouping rules under section 469 an appropriate method for determining whether a taxpayer can aggregate trades or businesses for purposes of applying section 199A.” See Chapter 3.24 for details on Sec 199A.
California does not conform to the Federal treatment of real estate professionals’ passive losses. Thus “real estate professionals” who materially participate in their rental activities may deduct their rental losses without limitation for Federal purposes, but they are limited by the passive loss rules for CA.