Defining "real estate professional" for PAL purposes.

• Author: Koppel, Michael D.
• Position: Passive activity loss

In 1993, enacted legislation sought to mitigate some inequities resulting from the passive activity loss (PAL) limit rules enacted in the mid-1980s. Simply put, a "real estate professional" can deduct certain rental real estate activity losses against all categories of income. However, the legislative relief has been narrowly applied in 1995 regulations and recent court cases. Only activities in which a taxpayer materially participates determine real estate professional status; this has proven to be a trap.

Sec. 469(c)(7)(B) defines a real estate professional as a taxpayer who (1) spends more than 750 hours and (2) performs more than one-half of his or her personal services during the tax year in real property trades or businesses in which he or she materially participates. Sec. 469(h) and Temp. Regs. Sec. 1.469-5T(a) apply in determining whether the material participation standard is met.

Tests

In determining whether a taxpayer meets the two time requirements in Sec. 469(c)(7)(B), only teal estate businesses in which the taxpayer materially participates are taken into account. If the two tests are met, the taxpayer is a real estate professional; Sec. 469(c)(7) exempts his or her rental activities from Sec. 469(c)(2), so they are not passive per se. The Temp. Regs. Sec. 1.469-5T tests are then applied to the taxpayer's rental activities. If these activities meet any of the temporary regulation's material participation tests, the losses therefrom are not PALs.

Rental real estate cannot be aggregated with nonrental real estate operations; thus, if X spends 600 hours developing real estate and 200 hours on each of his four rental real estate activities, he is not a real estate professional. If a taxpayer spends 750 hours and more than one-half of his or her time on development, the taxpayer may be a real estate professional, but the rental losses may not be deductible...