The Pros & Cons of Making the Grouping Election for Your Rental Real Estate ActivitiesJanuary 19, 2015
What you need to know about the election, who can make it and what the requirements are.
*Editor’s Note: This blog has been updated as of March 4, 2021 for accuracy and comprehensiveness.
If you have several rental activities, and cannot meet the material participation rules for any single activity, the grouping election allowed under IRC §469 may be a good option. Here is what you need to know about the election.
What is the election? The election is a statement that is required to be attached to your tax return. The election must be filed by the due date of the tax return, including extensions for the year in which the taxpayer wishes to make the election. Once the election is made, it cannot be changed except for in specific circumstances.
Who can make it? The election can be made by individuals, C Corporations, S Corporations, Partnerships, Trusts and Estates
What are the pre-requisites? You must first meet the definition of a qualifying real estate professional except for the fact that you do not materially participate in any one activity. A taxpayer qualifies as a real estate professional if (1) more than one-half of the personal services the taxpayer performs in trades or businesses during the tax year are in real property trades or businesses in which the taxpayer materially participates, and (2) hours spent providing personal services in real property trades or businesses in which the taxpayer materially participates total more than 750 during the tax year. The election allows you to group certain activities together and treat them as one activity. The activities must constitute an “economic unit” which means that the activities must be related. The Regulations state that the taxpayer can use any reasonable method to make this determination, and that the following factors are given the most weight when determining an economic unit: Similarities of the business, extent of common control, extent of common interest, geographic location, and interdependence of the activities.
What are the pros of making the election? Starting for the year in which the election is made, losses that would have been suspended by the passive activity rules will now be deductible as expenses of a qualifying real estate professional for all of the activities that are part of the grouping election.
What are the cons of making the election? Even though the activities have been grouped, any prior year suspended passive activity losses are not freed up or usable against other income after making the election. Only losses incurred from the year of election and going forward are allowed to be deducted. The other drawback is that if one activity from a group is sold during the year, prior year suspended passive losses from that property will not be freed up and allowed to be deducted until all of the activities in the group are sold.
Making the grouping election can be very beneficial, but could also produce unintended negative consequences. There are also many other facts that should be considered before making the election.
If you have rental real estate and are considering the grouping election, please contact us. We can help you sort through the complexities and determine the strategy that’s right for your particular situation.