The IRS issued Revenue Procedure 2011-34, which became effective on May 26, 2011 and allows a taxpayer to obtain an extension of time to make the rental real estate grouping election under Internal Revenue Code Section 469(c)(7)(A). This election applies to taxpayers who meet the real estate professional rules under the Internal Revenue Code and helps these taxpayers avoid the passive activity rules with regard to their rental real estate activities.
Normally, losses from a rental real estate activity are considered "passive" and can only be used to offset "passive" income from other activities. If there is no passive activity income then the losses are currently disallowed and are carried forward to a future year. However, if a taxpayer is considered a real estate professional, then losses from a rental real estate activity in which the taxpayer materially participates are not considered passive and may be currently deducted.
The material participation tests generally require a taxpayer to spend a certain number of hours participating in an activity during the year. If a taxpayer has numerous rental activities, it may be difficult or impossible to participate for the requisite number of hours in each of them, leading to disallowed losses.
Congress has provided a grouping election to assist real estate professionals with multiple rental real estate activities in meeting the material participation tests. The election allows a real estate professional to group all of his/her rental real estate activities into a single activity. This means that the taxpayer only needs to participate for a certain number of hours in the rental real estate activities as a whole rather than meeting the participation threshold for each activity separately.
For example, assume a real estate professional owns four rental real estate properties and participates for 150 hours in each. Further assume that the law requires the taxpayer to participate for more than 500 hours in an activity to meet the material participation rules. Because the taxpayer participates for less than 500 hours in each rental property, he does not materially participate in any of them, and therefore any losses from the properties are considered passive and may be currently nondeductible.
However, if the taxpayer makes the election to group the rental properties together as a single activity, he would aggregate all of his hours of participation in each property to determine whether he exceeds the 500 hour threshold. Since his total participation of 600 hours exceeds 500 hours, the losses from all of his rental properties would be considered non-passive and may be currently deducted.
The problem with this election is that it is only valid if the taxpayer files the required election statement with his/her tax return. Once the election is made, it applies for all future years in which the taxpayer qualifies as a real estate professional. Unfortunately, some real estate professional taxpayers having met all of the other requirements under the Internal Revenue Code and Regulations failed to include the election statement in their tax returns. In prior years, these taxpayers had to go through the expensive and arduous task of requesting a private letter ruling from the IRS to ask for an extension of time to make the grouping election.
Revenue Procedure 2011-34 makes it much easier for taxpayers to request an extension of time to make the election. A taxpayer can now simply amend the most recently filed tax return and attach a signed and dated declaration which includes the election language, an explanation of the reasonable cause for failing to file the election and an indication of the taxable year for which the election pertains. For example, a taxpayer who first became a real estate professional in 2002 but never included the grouping election in the 2002 timely filed tax return could follow the guidance in Revenue Procedure 2011-34 and have the election apply retroactively back to 2002. This relief is only available for taxpayers who have timely filed all applicable prior year tax returns as if the grouping election had been made.
Please contact us with any questions regarding how Revenue Ruling 2011-34 may impact you.
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