Real Estate Professional Rules Confirmed
The IRS in Chief Counsel Advice confirmed a position I have taken and for which I have advocated throughout the years. Many professionals disagreed, but now it is clear.
Generally, under Internal Revenue Code (IRC) section 469, real estate rental activities are passive activities subject to the loss limitation rules of IRC section 469, regardless of the owner’s level of participation. However, IRC section 469(c)(7) provides rules that allow real estate professionals to treat certain real estate rental activities as non-passive; and therefore, not subject to the IRC section 469 loss limitations.
A real estate professional is a taxpayer who performs more than 750 hours of service and more than half of all services during the year in real property trades or business in which he or she materially participates. There are a lot of separate rules to pass in that sentence! If married taxpayers file a joint return, only one spouse needs to pass each of the rules for them to apply to both on such a return.
When determining whether one materially participates in such real property trades or businesses, the normal IRC section 469 participation rules and definitions of activities apply. This includes grouping separate trades or businesses and rental operations; and a spouse’s participation counting for the other spouse.
Once an individual qualifies as a real estate professional, the treatment of real estate rental properties as passive is determined separately to each interest in real estate, even if they are grouped under the material participation test used to qualify as a real estate professional. However, IRC section 469(c)(7)(A) allows one to combine all interest in real estate rental properties as one activity to determine the passive or non-passive classification. This grouping election is done after the taxpayer qualifies as a real estate professional, not to determine if they are one.
That is where many professionals misinterpreted IRC section 469(c)(7)(A). They claimed the grouping election was used in applying the test to determine real estate professional status. CCA 201427016 makes it clear, it doesn't.