Self-rental rule not affected by grouping activities.

• Author: Carlos, Tony R.

The Tax Court has concluded that self-rental income rechararacterized as nonpassive income under Regs. Sec. 1.469-2(f)(6) is not included in the computation of passive activity losses (PALs), even if the self-rental activity is aggregated with the taxpayer's other passive activities under Pegs. Sec. 1.469-4(c).

Facts

P and his wife (collectively referred to as P) owned two commercial real estate properties (B and G). P also owned all of the stock of two S corporatious--a steal company and a restaurant. P leased B to the steel company, and G to the restaurant.

P grouped B and G together to constitute a single "activity." P netted the B income and the G loss on Schedule E, Supplemental Income and Loss, reported the net rental income as not from a passive activity and reported no PAL. However, the IRS disallowed P's net loss on the G property as a PAL, under Sec. 469(a).

Discussion

Sec. 469(a) disallows the PAL of an individual taxpayer. A passive activity is an activity involving the conduct of a trade or business in which the taxpayer does not materially participate. Under Sec. 469(c)(2), however, most rental activities are passive, regardless of material participation.

Regs. Sec. 1.469-4(c) sets forth rules for grouping tax items together to determine what constitutes a single "activity." It provides: "One or more trade or business activities or rental activities may be treated as a single activity if the activities constitute an appropriate economic unit for the measurement of gain or loss for purposes of section 469." Whether activities are an "appropriate economic unit" depends on the facts and circumstances. The IRS concedes that P's grouping of B and G is an appropriate economic unit. The parties, however, dispute the method for computing the PAL within the "activity" grouping.

Loss Computation

Sec. 469(d)(1) defines a PAL as "the amount (if any) by which--(A) the aggregate losses from all passive activities for the taxable year, exceed (B) the aggregate income from all passive activities for such year." A PAL is computed by first netting items of income and loss within each passive activity and then subtracting the aggregate income from all passive activities from aggregate losses.

Sec. 469(c)(2)'s general rule characterizes all rental activity as passive. However, under an exception in Regs. Sec. 1.469-2(f)(6), net rental...