RE Professional - can I deduct losses from rental AND syndicate?

Question

Assume that (in a given year) I'm a Real Estate Professional, and I've passed both the 750 hour test for my real estate activity and the 500 hour material participation test for a rental property I own and manage. Assumed this rental property generates tax losses (due to depreciation) - I understand I can deduct these losses from normal W2 income that my wife earns.

Now, assume that in this year I invest in a syndicated rental property investment (as a non-managing limited partner). Assume that this investment generates tax losses (again due to depreciation) that are reported to me on a K1.

Questions:

• Can I make the grouping election (IRS Regs. Sec. 1.469-9(g)) and elect to group my rental property and my syndicate investment so that I can deduct the sum of the losses from my wife's W2 income? 
• Is there some reason I would not want to make the grouping election, and would instead want to take only the losses from the rental property I directly own and manage as deductions against W2, while taking the investment losses as normal passive losses?I believe the main reason I'd not want to group is if the timeline for selling the rental property is significantly different than the timeline for the investment syndicate to be wrapped-up - because I can't deduct suspended losses until BOTH the rental property and the investment are disposed of.
• I believe the main reason I'd not want to group is if the timeline for selling the rental property is significantly different than the timeline for the investment syndicate to be wrapped-up - because I can't deduct suspended losses until BOTH the rental property and the investment are disposed of.

• I believe the main reason I'd not want to group is if the timeline for selling the rental property is significantly different than the timeline for the investment syndicate to be wrapped-up - because I can't deduct suspended losses until BOTH the rental property and the investment are disposed of.

(This very comprehensive article by Tony Nitti was helpful for understanding many details of the Real Estate Professional qualification, but after a few careful readings, I'm still left with the questions above)

Eamonn McElroy · Answer

@Cooper Marcus

Take a look at Treas Reg Sec 1.469-9(f).

Ivan Barratt · Answer

Not a CPA giving advice but I think yes you can. HIGHLY recommend you switch to an accounting firm with several partners in various disciplines!  I use a great one here in Indianapolis.  I believe they have clients across the country.

Eamonn McElroy · Answer

@Cooper Marcus

Perhaps it's more digestible to say more restricted threshold.

I consider the 500 hour standard one of the highest thresholds and one of the hardest to meet of the 7 standards for material participation, thus higher threshold in my mind...

Cooper Marcus · Answer

Thanks @Eamonn McElroy - Tony Nitti's articles and podcast appearances are what got me interested in this subject in the first place! He is a terrific resource.

Yes, it is certainly inadvisable to fully DIY this sort of thing, you are totally correct - I'm only trying to have a well-informed opinion so that when I sit down with my tax strategist (I'm still looking for a tax strategist :) I can say "here are my goals, and here is what I believe so far about achieving them - let's make that plan better, together".

Only once that plan is well-considered by an expert (heck, maybe even two!) and well understood by me, will I put the plan into practice.

Thanks for confirming my understanding in my previous post - I find that understanding so... strange, because the 500 hours that pass the test for materially participating in "LP + Rental" grouping is precisely the same 500 hour that pass the test for materially participating in "Rental" alone.

In your post just above you mention "you have to meet a higher threshold..." and I've seen similar language in other postings. The "higher threshold..." part got me confused because 500 hours in managing the rental is... no higher than 500 hours in managing the rental - it is the same threshold level, and it is met with the same hours spent!

Anyways, you are right, my next step here is getting 1-on-1 with an expert - once I do, I'll be sure to share what I learn back here on the fantastic resource that is BiggerPockets!

Eamonn McElroy · Answer

@Cooper Marcus

It's a two step process.  First you need to qualify as an RE professional.  You only count hours in real property trades or businesses in which you materially participate.  You don't group this step.  You cannot count your hours as an employee in a real property trade or business unless you own at least 5% of the company.

Then assuming you are a RE professional, you can elect to group all rental real estate activities for a material participation assessment.  If you own some rental real estate activities as an LP or the functional equivalent of an LP (e.g. non-member manager LLC interest), again -- you have to meet a higher threshold for material participation on the group.  I.e. you can only use 3 out of the 7 material participation tests to qualify the group.

There is nuance involved and I would highly encourage you to have a deep conversation with your CPA before you start making business decisions surrounding this.  I would not encourage you to DIY it.  There are too many unknowns and info left off the table as far as your facts and circumstances go -- and we haven't even considered your goals yet.

You tell us to assume you are an RE pro but that also demands we assume you have a good grasp of the IRC Sec 469 and the related regs...  What if you don't?  At that point the house is built on sand...figuratively speaking...  You are spending 500+ hours per year managing one rental?  How many units? Surely it's not a SFR...

High level yes -- your understanding is correct regarding your last post.  But we're working with a lot of assumptions for key steps.  We're also assuming a rental real estate grouping election is a good thing.  It isn't best for everyone all of the time.  It has ramifications and downsides.  Again, that deep convo is needed.

Here is a good article by Tony Nitti that explains the entire Sec 469 rental real estate process in layman's terms: https://www.thetaxadviser.com/issues/2017/mar/navigating-real-estate-professional-rules.html

Cooper Marcus · Answer

Here is the part I don’t get - if I spend 500+ hours materially participating in the rental property I own, have I just automatically made material any further activities I group with the rental property?

Thus, if I group the limited partnership with the owned rental property, does the group “instantly” pass the material participation test (because I spent 500+ hours in total across the members of the group)?

Ashish Acharya · Answer

I agree with my friend Eamonn.

Yes, you can elect to group the limited partnerhsip activity with your rental activity. If the election is made, material participation is determined for the combined activity as a whole. Generally, if any of the taxpayer's rental real estate activities are held as limited partner interests, the combined activity is treated as a limited partner interest.

Because limited partners have only 3 test out if 7 tests available to prove the material participation, it sometimes might not beneficial.

Consequently, the taxpayer is considered to have materially participated in the combined activity only if one of the three material participation tests applicable to limited partners is satisfied. However, if less than 10% of the taxpayer's share of gross receipts from rental real estate activities comes from limited partner interests, the combined activity is not treated as a limited partner interest. In such cases, a taxpayer is considered to have materially participated in the combined activity if any of the seven material participation tests.

So, first figure out if your LP gross receipt is less than 10%. If that is the case, grouping makes sense if you already materially participate in the other rental (ignoring all other such as your long term holding goes)

If it is more than 10%, then you probably need to meet "more than 500 hours" test to make the combined activity as non-passive. if not, you will lose the deduction from your otherwise deductible rental activity if it was not combined.

Cooper Marcus · Answer

Thanks @Eamonn McElroy - when you say "...raises the bar for the material participation requirement..." can you clarify what it raises it to?

If, prior to grouping a syndicate interest, the bar for material participation is satisfying one of the seven tests in Temp. Regs. Sec. 1.469-5T(a), what is the bar for material participation after grouping a syndicate interest?

Eamonn McElroy · Answer

@Cooper Marcus

Your understanding is mostly solid.  My original comment stands:

(1) Grouping a syndicate interest with other real property interests often raises the bar for the material participation requirement under the passive activity losses regs unless the LP is de minimis.

An LLC interest is affected as well if you are the 'functional equivalent' of a limited partner in said LLC.

Cooper Marcus · Answer

My original question is extensively discussed in https://www.biggerpockets.com/forums/51/topics/647412-syndication-losses-against-active-income

RE Professional - can I deduct losses from rental AND syndicate?

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