Real Estate Professionals should file Section 469 Election
July 30, 2004
By Jim Harnsberger, Sr. Tax Analyst

SAN DIEGO –As a general rule passive activity losses can offset only passive income and cannot be used to reduce active or portfolio income. Also tax credits derived from passive activity can offset only taxes incurred from passive income. Any loss or credit that is disallowed becomes suspended and is treated as a deduction or credit allocable to such activity in the next taxable year.

IRC section 469 (c)(2) says any real estate rental activity automatically is treated as a passive item unless the taxpayer qualifies as a real estate professional. The Revenue Reconciliation Act of 1993 allows real estate professionals who spend the majority of their time engaged in real estate activities to avoid the passive loss limitations. Instead, the rental real estate activity of a qualifying taxpayer who materially participates in the activity is not subject to the passive activity rules of section 469. Sec. 469(c)(7); sec. 1.469-9(e)(1), Income Tax Regs.

These rules apply as if each real estate rental activity is a separate business. However IRC section 469(c)(7)(A) allows a qualifying real estate professional to elect to treat all such activities as if it were one single activity for tax purposes. Such an election not only eases the burden of meeting the material participation tests but also allows the taxpayer to currently offset the losses from one rental activity against the income of another and then offset the remaining loss against non-passive-activity income. This election is an affirmative election that must be made by the taxpayer if he or she is to receive the benefits. See Kosonen v. Commissioner TC Memo 2000-10.

Most important in this “election” is the fact that all rental activities are treated as if they were one single economic unit. The fact that property is acquired and “flipped” does not necessarily mean that a Section 469 Election need be made due to the “intent” of the taxpayer being that the property being flipped (purchased and qucikly sold such as foreclosures) is not being held for “rental purposes.

Reporting of the business activity is made through filing Schedule C (Self Employment) of the entity Form if the taxpayer is conducting the business through a corporation or Limited Liability Company. In the case of Single Member LLC’s the taxpayer must still use Schedule C to report the income and expenses, unless a Form 8832 Election is filed to tax the LLC as a corporation.

Real Estate professionals are advised to file a Section 469 Election and to maintain contemporaneous records of ALL activity involved in the pursuit of the “business” engaged in. San Diego based Tax Smart America has developed a unique business methods patent for this industry segment to address virtually every aspect of the business of real estate. You may visit the company at its website at www.Taxsmartamerica.biz or call (619) 469-5800 for a free consultation.