The IRS recently released an important ruling affecting “real estate professionals” with losses from multiple rental activities. Revenue Procedure 2011-34 (http://www.irs.gov/pub/irs-drop/rp-11-34.pdf) allows Real Estate Professionals with more than one rental activity (property) to aggregate all rental activities into one activity. The election to aggregate activities can now be made retroactively.
Why is this important? The law states that real estate professionals must “actively participate” in rental activities in order to deduct losses from those activities. Generally, this loss deduction can offset not only passive income but also income from non-passive activities, such as salary or profits from real estate sales, to the extent of $25,000 per year. Non-deductible current losses are “suspended” and indefinitely carried forward to future years.
There are several tests to qualify for active participation, but perhaps the most onerous involves time spent on the activity. To qualify for real estate professional treatment, you are required to participate in real estate trades or businesses more than 750 hours per year, and the time spent in the real estate trade has to exceed the time you spend in any other activity. Think 14 hours per week. Unless aggregated, that’s 14 hours per week for each property. For multiple properties, the time requirement can present some obvious challenges. An inability to substantiate required time involvement can have disastrous results upon audit.
Are there disadvantages to aggregating rental activities? One potential disadvantage has to do with dispositions. If you sell a rental property which constitutes an “activity”, suspended passive losses are released in full in the year of disposition, regardless of the $25,000 ceiling on passive losses. If all activities are aggregated, a disposition of one property will release suspended losses only to the extent of gain on the sale of that property.
So, should you make the election to aggregate your real estate rental activities? As with all tax decisions, the only correct answer is - it depends. If substantiating 750 hours per activity is a challenge, the election should be seriously considered. If you have substantial suspended passive losses in an activity that you plan to sell soon, it may be better to wait.
As always, consult with your tax advisor. No tax decision should be made in a vacuum, but rather should consider your personal circumstances.