Syndication losses against active income

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Syndication losses against active income

Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes

Posting my response to a client's question, in order to get my colleagues input on this issue.

Q: I have an investor who is actively investing in real estate on their own & have no f/t job. So spending enough time in the industry to claim the "active RE pro" status on the tax return. Can they claim their income/loss from syndications where they invest as LP against their active income? 

A: I despise the word "syndication." :)  It recently became as meaningless as "business" or "investment." 200 people contributing $50k each for a large commercial deal is called syndication, and so is 3 friends putting $10k apiece as a down payment for a duplex. This distinction matters.

For tax purposes, there's a concept of active participation. It basically means participating in management decisions, such as approving tenants or lease terms, approving capital improvements and contractors, and so on. This is likely to be a yes in a 3-people scenario and likely to be a no in a 200-people scenario. 

Another requirement for active participation is owning at least a 10% interest - which again eliminates large syndications.

The third requirement for active participation is to not be a limited partner. In case of an LP it's a deal-breaker. If it was an LLC, as opposed to an LP, then there is significant controversy as to whether or not LLC members are treated as limited partners.

Now, to your question.

Without active participation (which is your case), passive losses from syndication can only offset passive income. So, if your client has some positive income (including capital gains) from his personal investments - he may not want to claim RE Pro status and use these gains against his K1 losses.

If he manages to qualify for active participation (a small syndication via an LLC, case by case) - then his K1 losses may offset his other income, up to $25k, as long as his income is under $100k. This $25k window is phased out between $100k and $150k income and then disappears.

PS. This is why we accountants have job security.

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John Woodrich
Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes
7y

@Michael Plaks I didn't read the above commentary and only put 5 minutes into this. Here is what I found in the Federal Tax Coordinator:

¶M-5004. Material participation by real estate professionals in rental real estate activities through limited partnerships.

With certain exceptions, all rental activities are automatically treated as passive activities, regardless of whether a taxpayer materially participates in the activity. See ¶ M-5101 et seq. Under one of the exceptions, the rental real estate activities of real estate professionals (as defined at ¶ M-5168 et seq.) aren't automatically treated as passive activities. As a result, if a real estate professional materially participates in a rental real estate activity, that activity is treated as not a passive activity. See ¶ M-5161 et seq. For purposes of this exception, a taxpayer may elect to aggregate all rental real estate interests and treat them as a single activity. See ¶ M-5163 et seq.

However, the above rules don't affect the determination of whether a taxpayer materially participates with respect to any interest in a limited partnership as a limited partner. 15 Moreover, the election to aggregate all rental real estate interests isn't intended to alter the rules relating to the material participation of a limited partner. 16

Checkmark RIA observation: In other words, the fact that a real estate professional's rental real estate activities (whether aggregated or not), conducted through limited partnership interests, aren't automatically treated as passive activities, under the rules explained at ¶ M-5161 et seq., doesn't mean that those activities are automatically treated as non-passive. For those activities to be treated as non-passive, the taxpayer must pass one of the material participation tests allowed to limited partners that's discussed at ¶ M-5003. Otherwise, the activity will be treated as passive.

If a taxpayer makes the election to treat all interests in rental real estate as a single rental real estate activity, and at least one interest in rental real estate is held by the taxpayer as a limited partnership interest (as defined at ¶ M-5002 and ¶ M-5003), the combined rental real estate activity is treated as a limited partnership interest of the taxpayer for purposes of determining material participation. Accordingly, the taxpayer won't be treated as materially participating in the combined rental real estate activity unless the taxpayer satisfies one of the material participation tests allowed to limited partners that's discussed at ¶ M-500317 Thus, a real estate professional must establish material participation in a rental real estate activity held, in whole or in part, by a limited partnership interest under one of the tests that apply to determine the material participation of limited partners. 18

If a real estate professional makes the election to treat all interests in rental real estate activities as a single rental real estate activity (see ¶ M-5163 et seq.), and the taxpayer's share of gross rental income from all of the taxpayer's limited partnership interests in rental real estate is less than 10% of the taxpayer's share of gross rental income from all of the taxpayer's interests in rental real estate for the tax year, the rule discussed at footnote 17 doesn't apply. In this case, the taxpayer may determine material participation under any of the tests discussed at ¶ M-490519

15 Code Sec. 469(c)(7)(A)

16 H Rept No. 103-111 (PL 103-66) p. 614

17 Reg § 1.469-9(f)(1)

18 Preamble to , 01/10/95.

19 Reg § 1.469-9(f)(2).

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  • Michael PlaksPro Member
    OP
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    7y
    Originally posted by @Account Closed:

    Wait till the next downturn.  You  will be able to raise your rates.  Instead of being upset at the syndicator all the wrath will come down on you.

    Not sure what you mean, sorry 

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  • Eamonn McElroy
    Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
    7y

    @Michael Plaks

    Is taxpayer in question a 'real estate professional'?  Not clear as client calls him/her an "active RE pro" and taxpayer in question may not be your client so you may not be familiar with facts and circumstances.

    I would take a look at Treasury Reg Sec 1.469-9(f) if taxpayer is a real estate professional and LP interest is involved with RRE activities, particularly 1.469-9(f)(2).

    If not a RE pro, Treasury Reg Sec 1.469-5T(e) reigns.

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  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
    7y

    @Michael Plaks , 

    This is my opinion. 

    Real Estate Profesional status is only relevant to determine if the rental losses are deductible. Once you achieve the status, the rental is not automatically considered passive for these RE Pros and material participation rule will determine if the losses could be deducted. So If someone materially participates in the rental, he/she can deduct the loss. 

    With the same logic, 

    The LP is still going to be passive income based on the participation level of the investor. (This is be with large syndication or any other normal business where you are hands-off limited partner)

    LLC's Limited interest was controversial but we do have guidance now. If LLC member passes one of the three tests, they are considered materially participating and loss will be deductible against other ordinary income even if they have limited interest:

    Limited partners are deemed to materially participate in a partnership's activities if they satisfy either 

    • 1) the hourly safe harbor test (500 hours)
    • 2) the historical participation test (Historical Participation. The taxpayer materially participated in the activity for any five of the 10 preceding tax years.)
    • 3) the personal service activity test: Taxpayer materially participated in a personal service activity for any three prior tax years. A personal service activity involves the performance of personal services in the fields of health, law, engineering, architecture, accounting, actuarial science, the performing arts, consulting, or any other trade or business in which capital is not a material income-producing factor.

    Read the support below if required. 

    Based on Temp. Reg. 1.469-5T(e)(3)(i)(B), it appeared that LLC members were treated as limited partners. The IRS Passive Activity Loss Audit Technique Guide (ATG) also indicated that LLC members should be treated as limited partners for PAL purposes. (ATGs can be found on www.irs.gov. Search for “audit technique guide.”) However, the courts have not agreed with the IRS's position regarding the application of the limited partner material participation rules to LLC members. In the Gregg decision, the U.S. District Court for Oregon held that an LLC member was not subject to the higher material participation standard applicable to limited partners, but only had to satisfy one of the regular seven material participation tests. More recently, in a series of cases (Garnett; Thompson; Newell), the courts found that the taxpayers' ownership interests in LLCs were excepted from classification as limited partner interests under the temporary regulations by operation of the general partner exception. In March 2010, the IRS acquiesced in result only to the Thompson decision. The Court in Thompson held that the taxpayer's interest was not a limited partner interest for purposes of IRC Sec. 469, and that even if the interest was treated as a limited partner interest, the taxpayer's interest would best be categorized as a general partner interest underTemp. Reg. 1.469-5T(e)(3)(ii). (An acquiescence “in result only” means the IRS accepts the holding of the court and will follow it in disposing of cases with the same controlling facts but is in disagreement with or has concerns about some or all of the court's reasons.)

    Prop. Reg. 1.469-5 which provides that an interest in an entity will be treated as an interest in a limited partnership if

    a) the entity is classified as a partnership for federal tax purposes, and

    b) the holder of the interest does not have rights to manage the entity at all times during the entity's tax year under the law of the jurisdiction in which the entity was organized and under the entity's governing agreement [Prop. Reg. 1.469-5(e)(3)(i)]. 

    Therefore, the owner of a limited partner interest must pass one of the three tests available for limited partners to meet the material participation requirement. Accordingly, the rules will no longer rely on limited liability, but will rely on the individual partner's right to participate in management of the activity. In addition, if a limited partner also has a general partner interest in the same partnership during the entire year, the individual is considered a general partner for determining material participation [Prop. Reg. 1.469-5(e)(3)(ii)]. 

    Let me know if you agree. 

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  • Michael PlaksPro Member
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    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    7y

    @Eamonn McElroy

    REPro is unrelated to the question, even though hinted at by my client. LP losses from syndication will not be part of REPro either way, because there is no way to pass material participation.

    We really should disregard the other investments and REPro mention altogether, as to not confuse the two separate topics.

    The question was - can LP losses be deducted against other income, which is an issue of the $25k active participation special allowance. Do you have comment on that part of my answer in the OP?

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  • Michael PlaksPro Member
    OP
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    7y

    @Ashish Acharya

    I agree with you, but it's not really related to the issue I was discussing with my client. All you're discussing is the material participation issue - i.e. can K1 rental losses pass material participation and be deducted as non-passive. This is a no in this case anyway.

    The issue I was addressing is whether it could pass active participation and be deducted as passive loss, under $25k special allowance.

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  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
    7y

    @Michael Plaks , 

    Sorry, if I was not clear. I meant the 25k active loss exception is not relevant for LP in LLC if they materially participate. I was assuming you were trying to discuss LP implication on the material participation.

    Based on the code[IRC Sec. 469(i)(6)(C)], looks like Limited partners cannot be active participants. See below. 

    Three issue: 

    • As you mentioned, for large syndications, the 10% interest rule is usually not met, even if active participation meets(which is also rare for most of the investor as they are LP), so there is no 25k exception for rental loss.  

    "If he manages to qualify for active participation (a small syndication via an LLC, case by case) - then his K1 losses may offset his other income, up to $25k, as long as his income is under $100k."

    • For duplex "syndication" I was implying that if the LP is deemed to materially participate with the three test rule  mentioned above, there is no need for 25k exception. The loss or gain is not passive for these LP. Grouping of activities under section 469 will be very handy here to meet the participation rule. 
    • If these LPs cannot group activities and are not materially participating(based on the three criteria), the 25k rule does not apply to LP as they are not deemed not to qualify for active participation. Code says that a taxpayer who owns rental real estate as a limited partner is not considered an active participant in the rental real estate activity for the $25,000 allowance [IRC Sec. 469(i)(6)(C)]. The Code authorizes the IRS to provide exceptions to this rule, but regulations have yet to be issued. When a taxpayer holds both a limited and general partner interest in the same partnership, the taxpayer may be deemed to actively participate in the activity by treating both interests as a general partner interest as allowed for material participation purposes. There is not currently any guidance on whether or how this provision will apply to LLC members.

    This looks like if you cant increase the participation to the material participation with the three test mentioned above, you can't qualify for the 25k loss deduction as LP are not deemed to actively participate. 

    What are your thoughts? 

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  • Eamonn McElroy
    Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
    7y

    As @Ashish Acharya has already mentioned, IRC Sec 469(i)(6)(C) prevents application of active participation to an LP interest.

    @Michael Plaks "REPro is unrelated to the question, even though hinted at by my client."

    I disagree.  If taxpayer is a real estate pro, which we haven't determined yet, has a grouping election in place, and the LP is involved in rental real estate, Treasury Reg Sec. 1.469-9(f) must be acknowledged.

    As mentioned above, Treas Reg 1.469-9(f)(2) becomes very important here as taxpayer may be able to classify the LP interest as non-passive via de minimis grouping and take the loss.

    (f)Limited partnership interests in rental real estate activities

    (1)In general

    If a taxpayer elects under paragraph (g) of this section to treat all interests in rental real estate as a single rental real estate activity, and at least one interest in rental real estate is held by the taxpayer as a limited partnership interest (within the meaning of § 1.469-5T(e)(3)), the combined rental real estate activity will be treated as a limited partnership interest of the taxpayer for purposes of determining material participation. Accordingly, the taxpayer will not be treated under this section as materially participating in the combined rental real estate activity unless the taxpayer materially participates in the activity under the tests listed in § 1.469-5T(e)(2) (dealing with the tests for determining the material participation of a limited partner).

    (2)De minimis exception

    If a qualifying taxpayer elects under paragraph (g) of this section to treat all interests in rental real estate as a single rental real estate activity, and the taxpayer's share of gross rental income from all of the taxpayer's limited partnership interests in rental real estate is less than ten percent of the taxpayer's share of gross rental income from all of the taxpayer's interests in rental real estate for the taxable year, paragraph (f)(1) of this section does not apply. Thus the taxpayer may determine material participation under any of the tests listed in § 1.469-5T(a) that apply to rental real estate activities.

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  • Michael PlaksPro Member
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    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    7y
    Originally posted by @Ashish Acharya:

    @Michael Plaks , 

    • As you mentioned, for large syndications, the 10% interest rule is usually not met, even if active participation meets(which is also rare for most of the investor as they are LP), so there is no 25k exception for rental loss.  

    "If he manages to qualify for active participation (a small syndication via an LLC, case by case) - then his K1 losses may offset his other income, up to $25k, as long as his income is under $100k."

    • If these LPs cannot group activities and are not materially participating(based on the three criteria), the 25k rule does not apply to LP as they are not deemed not to qualify for active participation... There is not currently any guidance on whether or how this provision will apply to LLC members.

    This looks like if you cant increase the participation to the material participation with the three test mentioned above, you can't qualify for the 25k loss deduction as LP are not deemed to actively participate. 

    What are your thoughts? 

    My first thoughts are - is everybody in Atlanta that argumentative, or only you and @Eamonn McElroy?  :)

    You and I are not disagreeing. LPs are out, for more than 1 reason. What I said, and you quoted me, was that small syndications organized as LLCs might be able to qualify for active participation and $25k. But it is controversial.

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  • Michael PlaksPro Member
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    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    7y
    Originally posted by @Eamonn McElroy:

    As @Ashish Acharya has already mentioned, IRC Sec 469(i)(6)(C) prevents application of active participation to an LP interest.

    @Michael Plaks 

    Not only Ashish, but I mentioned it myself. I never suggested that LP could qualify for active participation. I suggested that a small LLC syndication possibly might.

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  • Michael PlaksPro Member
    OP
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    7y

    You seem to imply that Reg. 1.469-9(f)(2) de minimis exception somehow allows LP interest to be piggybacked on another material participation. 

    Not so. All that paragraph does is allows to apply any of the 7 material participation criteria, instead of only 3 (which is the case for regular LP interest.) De minimis or not, the LP interest still has to separately qualify for material participation.

    Where I agree with you is that, should the LP interest somehow qualify for material participation, it then could push its losses thru the REPro loophole if available. However, I just don't see how rental syndication interests could pass the material participation test. But yes, if they do, then there is possibly this other route to deducting losses.

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  • Joseph ODonovanPro Member
    Property Manager · Ridley, PA · Member since 2017 · 427 posts · 449 votes
    7y
    @Michael Plaks 20 years ago I left the Accounting Field. Now I know why.
    2Reply
  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
    7y
    Originally posted by @Michael Plaks:
    Originally posted by @Ashish Acharya:

    @Michael Plaks , 

    • As you mentioned, for large syndications, the 10% interest rule is usually not met, even if active participation meets(which is also rare for most of the investor as they are LP), so there is no 25k exception for rental loss.  

    "If he manages to qualify for active participation (a small syndication via an LLC, case by case) - then his K1 losses may offset his other income, up to $25k, as long as his income is under $100k."

    • If these LPs cannot group activities and are not materially participating(based on the three criteria), the 25k rule does not apply to LP as they are not deemed not to qualify for active participation... There is not currently any guidance on whether or how this provision will apply to LLC members.

    This looks like if you cant increase the participation to the material participation with the three test mentioned above, you can't qualify for the 25k loss deduction as LP are not deemed to actively participate. 

    What are your thoughts? 

    My first thoughts are - is everybody in Atlanta that argumentative, or only you and @Eamonn McElroy?  :)

    You and I are not disagreeing. LPs are out, for more than 1 reason. What I said, and you quoted me, was that small syndications organized as LLCs might be able to qualify for active participation and $25k. But it is controversial.

     Micheal, sorry if I came across argumentative.  It often happens via messages without emotions,  not actually intended. 

    And, I have in person met Eamonn, he is the nicest guy you will ever meet. 

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  • Eamonn McElroy
    Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
    7y

    @Michael Plaks

    "Not only Ashish, but I mentioned it myself. I never suggested that LP could qualify for active participation. I suggested that a small LLC syndication possibly might."

    Agree with both your and Ashish's analysis of 'active participation' and LLCs.

    Where we disagree is LPs...

    "You seem to imply that Reg. 1.469-9(f)(2) de minimis exception somehow allows LP interest to be piggybacked on another material participation.

    Not so. All that paragraph does is allows to apply any of the 7 material participation criteria, instead of only 3 (which is the case for regular LP interest.) De minimis or not, the LP interest still has to separately qualify for material participation." [Emphasis Added]

    Nowhere in IRC Sec 469 or the related Treasury Regs does it say the emphasized portion...  Very interested in reading the source material you've read that from if it is authoritative.

    Respectfully, you're misinterpreting Treas Reg Sec. 1.469-9(f) and I believe an aspect of the rental real estate grouping election available to real estate professionals.

    Your client's question to you was:

    "I have an investor who is actively investing in real estate on their own & have no f/t job. So spending enough time in the industry to claim the "active RE pro" status on the tax return. Can they claim their income/loss from syndications where they invest as LP against their active income?" [Emphasis Added]

    Active participation is just one way to take the losses from syndications against non-passive income, although it is subject to restriction which you and Ashish have already touched upon.  The other way is to make the syndications themselves non-passive using IRC Sec 469 and the related regs.

    Why am I so focused on Treas Reg Sec. 1.469-9(f) -- which I've posted in full above -- and the taxpayer's potential status as a 'real estate professional'?

    IRC Sec 469 generally characterizes rental real estate as per se passive under IRC Sec 469(c)(2).

    If the taxpayer is able to qualify as a real estate professional under IRC Sec 469(c)(7)(B), IRC Sec 469(c)(7)(A) allows the taxpayer to apply a material participation test to his/her rental real estate activities for a passive / non-passive determination.  i.e. The taxpayer's rental real estate activities are no longer per se passive and the taxpayer may use any of the 7 bright line tests under Treasury Reg Sec 1.469-5T(a) to determine material participation.

    What is interesting is that by default IRC Sec 469(c)(7)(A) and Treas Reg Sec 1.469-9 prescribe that each rental real estate activity must qualify for material participation on its own for the determination.  However...  an election to group all rental real estate activities as a single unit and apply the material participation tests to the group for a passive / non-passive determination on the group as a whole is available.

    It should be noted that under the grouping election of Treas Reg Sec 1.469-9, it's all or nothing.  All rental real estate activities are grouped if the election is made.  That includes RRE activities held directly, RRE activities held through an LLC (no matter the ownership percentage), RRE activities held through an LP (no matter the percentage), etc.

    This stands in stark contrast to the grouping election under Treas Reg Sec 1.469-5, which does allow the taxpayer to "pick and choose".

    Now...What happens if the taxpayer is a real estate professional, has made or will make an election to group all rental real estate activities, and has one or more interests in rental real estate as a limited partner?

    Treas Reg Sec 1.469-9(f)(1) prescribes that in this fact pattern, an additional restriction is placed upon the material participation determination.  The entire grouped rental real estate activity is now treated as a limited partnership interest for purposes of determining material participation.  This means, in effect, all 7 bright line tests can no longer be used to determine material participation.  Only paragraph (a)(1), (5) or (6) of Treasury Reg Sec 1.469-5T(a) can be used.  So...in essence, Treas Reg Sec. 1.469-9(f)(1) functions as an "anti-abuse" rule of sorts to prevent a RRE professional from downsizing his own RRE activities in relation to his "managed" RRE activities.

    Treas Reg Sec 1.469-9(f)(2) provides a de minimis exception to (f)(1), and may very possibly allow the taxpayer in your client's question to achieve what he's trying to achieve, which is why I am so hyper focused on it.

    Treas Reg Sec 1.469-9(f)(2) prescribes that if a real estate professional elects to group all rental real estate activities, and the pro-rata portion of his/her gross receipts of rental real estate activities held as a limited partner is less than 10% of all gross receipts from all of his/her rental real estate activities, Treas Reg Sec 1.469-9(f)(1) will not apply.  That is, the taxpayer has the full suite -- all 7 bright line tests -- under Treasury Reg Sec 1.469-5T(a) to make a material participation determination (i.e. passive /non-passive) on the rental real estate group as a whole.

    As previously noted, when election to group is made under "-9", it includes all rental real estate activities -- even those held as a limited partner.

    When you group, you make a material determination on the group as a whole.  If you meet material participation with respect to the group, all activities in the group are determined to be non-passive.

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  • Eamonn McElroy
    Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
    7y

    @Ashish Acharya "And, I have in person met Eamonn, he is the nicest guy you will ever meet."

    Well I don't know about that...  ; )

    @Michael Plaks

    Only trying to help, as always....apologies if I came across in any other manner.  Iron sharpens iron, or so they say...

    And yes, we're the only two argumentative ones in the whole city.  ; ) 

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  • Ethan Henning
    Real Estate Agent · Atlanta, GA · Member since 2015 · 295 posts · 117 votes
    7y

    This might be the dumbest I have ever felt on BiggerPockets. haha

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  • Michael PlaksPro Member
    OP
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    7y
    Originally posted by @Eamonn McElroy:

    @Ashish Acharya "And, I have in person met Eamonn, he is the nicest guy you will ever meet."

    Well I don't know about that...  ; )

    @Michael Plaks

    Only trying to help, as always....apologies if I came across in any other manner.  Iron sharpens iron, or so they say...

    And yes, we're the only two argumentative ones in the whole city.  ; ) 

    Are you both seriously apologizing? C'mon, friends, I was just joking. Even put a smiley after that. I love a good argument with knowledgeable peers! 

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  • Michael PlaksPro Member
    OP
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    7y
    Originally posted by @Eamonn McElroy:

    @Michael Plaks

    Where we disagree is LPs...

    "You seem to imply that Reg. 1.469-9(f)(2) de minimis exception somehow allows LP interest to be piggybacked on another material participation.

    Not so. All that paragraph does is allows to apply any of the 7 material participation criteria, instead of only 3 (which is the case for regular LP interest.) De minimis or not, the LP interest still has to separately qualify for material participation." [Emphasis Added]

    Nowhere in IRC Sec 469 or the related Treasury Regs does it say the emphasized portion...  Very interested in reading the source material you've read that from if it is authoritative.

    Respectfully, you're misinterpreting Treas Reg Sec. 1.469-9(f) and I believe an aspect of the rental real estate grouping election available to real estate professionals.

    ...

    When you group, you make a material determination on the group as a whole.  If you meet material participation with respect to the group, all activities in the group are determined to be non-passive.

    We seem to get confused as to where we agree and where we don't.

    1. LLCs and active participation - we agree, case closed.

    2. Regs 1.469-9(f) de minimis. You believe we disagree, and you go to great lengths to restate your position - but we actually agree! All that de minimis does is allows 7 tests instead of the 3 tests for the applicable LP interests - same thing that I said, just different wording.

    3. Now, where we disagree is the relationship between an election to aggregate and the material participation test.

    My position is that LP interests included in the aggregate activity still have to separately qualify for material participation. It is based on my reading of Sec. 469(c)(7)(A):

    "...Notwithstanding clause (ii), a taxpayer may elect to treat all interests in rental real estate as one activity. Nothing in the preceding provisions of this subparagraph shall be construed as affecting the determination of whether the taxpayer materially participates with respect to any interest in a limited partnership as a limited partner..."

    Your position is that, once an election to aggregate is made, it becomes one activity, and the material participation test should only be applied at the level of the aggregated activity, including LP interests.

    You may be right, and I may be wrong on this one - but I'm not yet convinced, and frankly do not have time to dig into it these days. An interesting point though, certainly worth looking into. Thanks for bringing it up.

    2Reply
  • Michael PlaksPro Member
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    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    7y

    @Brandon Hall , @Steven Hamilton II and @John Woodrich - do you have something to say about the last one item? 

    Once you aggregate activities, including LP interests, are LP interests spared from having to separately meet material participation?

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  • John Woodrich
    Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes
    7y

    @Michael Plaks I didn't read the above commentary and only put 5 minutes into this. Here is what I found in the Federal Tax Coordinator:

    ¶M-5004. Material participation by real estate professionals in rental real estate activities through limited partnerships.

    With certain exceptions, all rental activities are automatically treated as passive activities, regardless of whether a taxpayer materially participates in the activity. See ¶ M-5101 et seq. Under one of the exceptions, the rental real estate activities of real estate professionals (as defined at ¶ M-5168 et seq.) aren't automatically treated as passive activities. As a result, if a real estate professional materially participates in a rental real estate activity, that activity is treated as not a passive activity. See ¶ M-5161 et seq. For purposes of this exception, a taxpayer may elect to aggregate all rental real estate interests and treat them as a single activity. See ¶ M-5163 et seq.

    However, the above rules don't affect the determination of whether a taxpayer materially participates with respect to any interest in a limited partnership as a limited partner. 15 Moreover, the election to aggregate all rental real estate interests isn't intended to alter the rules relating to the material participation of a limited partner. 16

    Checkmark RIA observation: In other words, the fact that a real estate professional's rental real estate activities (whether aggregated or not), conducted through limited partnership interests, aren't automatically treated as passive activities, under the rules explained at ¶ M-5161 et seq., doesn't mean that those activities are automatically treated as non-passive. For those activities to be treated as non-passive, the taxpayer must pass one of the material participation tests allowed to limited partners that's discussed at ¶ M-5003. Otherwise, the activity will be treated as passive.

    If a taxpayer makes the election to treat all interests in rental real estate as a single rental real estate activity, and at least one interest in rental real estate is held by the taxpayer as a limited partnership interest (as defined at ¶ M-5002 and ¶ M-5003), the combined rental real estate activity is treated as a limited partnership interest of the taxpayer for purposes of determining material participation. Accordingly, the taxpayer won't be treated as materially participating in the combined rental real estate activity unless the taxpayer satisfies one of the material participation tests allowed to limited partners that's discussed at ¶ M-500317 Thus, a real estate professional must establish material participation in a rental real estate activity held, in whole or in part, by a limited partnership interest under one of the tests that apply to determine the material participation of limited partners. 18

    If a real estate professional makes the election to treat all interests in rental real estate activities as a single rental real estate activity (see ¶ M-5163 et seq.), and the taxpayer's share of gross rental income from all of the taxpayer's limited partnership interests in rental real estate is less than 10% of the taxpayer's share of gross rental income from all of the taxpayer's interests in rental real estate for the tax year, the rule discussed at footnote 17 doesn't apply. In this case, the taxpayer may determine material participation under any of the tests discussed at ¶ M-490519

    15 Code Sec. 469(c)(7)(A)

    16 H Rept No. 103-111 (PL 103-66) p. 614

    17 Reg § 1.469-9(f)(1)

    18 Preamble to , 01/10/95.

    19 Reg § 1.469-9(f)(2).

    3Reply
  • Cooper Marcus
    Rental Property Investor · San Francisco, CA · Member since 2019 · 42 posts · 16 votes
    7y

    I asked a similar question to the original post here https://www.biggerpockets.com/forums/51/topics/716878-re-professional-can-i-deduct-losses-from-rental-and-syndicate - I should have found this thread first, but after reading it, I'm still wondering what the answer is.

    Perhaps you can point out the fault with the following logic (and forgive me for incorrect terminology - I'm a bit of a beginner)

    1. Let's assume the tax payer is a Real Estate Professional (due to 750+ hours actively managing rental properties they own, no other job that consumes more of their time, etc).
    2. They put more than 500 hours in total into actively managing their rental properties and they elect to group the properties - this thus allows them to deduct their rental-related passive losses from ordinary income.
    3. They acquire an interest in a rental property LLC - let's assume it is NOT the "3-friends buying a duplex together" scenario posted originally, and it is more like the "200-people" scenario.
    4. The new LLC interest is automatically grouped with their owned rental property.
    5. To maintain the deductibility of their rental real estate-related passive losses from ordinary income, the grouped real estate activities must pass the material participation test - which it "automatically" does, because in step #2 they put in more than 500 hours to actively managing some members of the group.

    While I'd like my logic to be correct, I'd be somewhat surprised if it was :)

    If it is correct, it seems to offer a loophole by which being a RE Pro, and spending 500+ hours managing rental property(s) you own, then allows you to deduct essentially unlimited losses from rental property LLC memberships against ordinary income.

    On the other hand, if this logic is incorrect, it is also a little surprising - because it implies that RE Pros cannot ever own interests in rental property LLCs (assuming they group activities) because the moment they acquire such an interest, they loose the ability to deduct ANY of their passive losses from ordinary income.

    Maybe this is why I've read that the grouping election is fraught? 

    0Reply
  • Matt BontragerBusiness Member
    CPA · Henderson, NV · Member since 2016 · 75 posts · 13 votes
    5y

    @Michael Plaks @Eamonn McElroy come on! Haha I was dying to finally find an answer!


    @Cooper Marcus I agree with the logic. 

    Podcast Guest on Show Seeing Greene: CPAs Answer YOUR Top Investing and Tax Questions
    0Reply
  • Michael PlaksPro Member
    OP
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    4y
    Originally posted by @Matt Bontrager:

    I was dying to finally find an answer!
    @Cooper Marcus I agree with the logic. 

    Gentlemen, I forgot about this 3-year old thread until one of my clients dug it out recently. Your logic is correct, Cooper. This is not a loophole. You basically earned your pass into the unlimited deductions buffet room with your personal rentals. Eat all you can/want now. 

    I wrote a new post clarifying this situation: https://www.biggerpockets.com/...

    0Reply
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