Passive loss relief for real estate professionals: fact or fiction?

• Author: Gladstone, Debra L.

The Revenue Reconciliation Act of 1993 (RRA) amended Sec. 469(c) to remove the "per se" passive taint on rental real estate for taxpayers actively engaged in real property businesses. New Sec. 469(c)(7) allows real estate professionals who meet specified thresholds to determine if their rental real estate activities are passive or active under existing regulations.

These regulations, which define activities and material participation, were proposed before 1993 and do not consider the RRA's special treatment for real estate professionals. The implementation of this new law through those regulations, coupled with recent unofficial and informal - but public - comments by Treasury personnel, may severely limit the legislative relief intended by Congress.

Existing regulations: activities

defined

An activity's identification is important because:

* Within an activity, gains and losses may be netted, regardless of whether the transaction giving rise to the gain or loss is passive or active.

* Material participation must be determined for each identified activity.

Prop. Regs. Sec. 1.469-4 indicates that a taxpayer may use any reasonable method to group or segregate activities. However, because of the special "per se" passive treatment of rental activities, certain disaggregation rules apply:

* Rental activities generally may not be grouped with a trade or business activity (Prop. Regs. Sec. 1.469-4(d)).

* Personal property and real property rentals generally may not be grouped (Prop. Regs. Sec. 1.469-4(e)).

* Limited partners and limited entrepreneurs generally may not group an activity described in Sec. 465(c)(1) (related to at-risk activities) with other activities (Prop. Regs. Sec. 1.469-4(f)).

Activities not specifically disaggregated are grouped based on whether they represent an appropriate economic unit (Prop. Regs. Sec. 1.469-4(c)(1) and (2)). Factors to consider include:

* Similarities and differences in types of business.

* Extent of common control.

* Extent of common ownership.

* Geographical location.

* interdependencies between the activities.

These regulations are proposed to be effective for tax years ending after May 10, 1992.

Existing regulations: material

participation

Temp. Regs. Sec. 1.469-5T requires a taxpayer to meet one of seven tests for material participation:

1. More than 500 hours of participation (Temp. Regs. Sec. 1.469-5T(a)(1)).

2. Substantially all participation in the activity is by the taxpayer (Temp. Regs. Sec...