Grouping Passive Activities

[Jason Watson]

Along with Material Participation as a Real Estate Professional, you might also want to consider grouping your activities together. So a common question that I get is-

Do I need to group my rental activities together?

Yes. Otherwise you will need to prove 750-hour rule for real estate professional for each property, including the proof of material participation in each property. That’s tough. The election is simply a statement that is attached to your tax return. And under Revenue Procedure 2010-13, you can make the election retroactively (typically requires amending a tax return just for the election).

Disallowed losses prior to grouping your rental activities together are suspended if you also claim the real estate professional designation with material participation. Unbundling is required during a sale of a property to deduct the disallowed and suspended losses.

Grouping also helps taxpayers obtain the 10% interest requirement in the activity for active participation.

Lastly, with the new Medicare surcharges being attached to passive incomes, grouping your activities into one activity while materially participating as a real estate professional allows you to minmize the tax consequences.

Are there downsides to the real estate professional designation?

Yes. But the downsides are obscure.

If you have other passive income you might want to keep your rental losses passive to offset this income. For example, you are an investor in an investment partnership that loses money and you have rental properties which make good money. If you consider yourself a real estate professional for your rentals, that income is no longer passive and will now be considered earned income. Your tax deduction from your investment partnership losses will be limited according to passive loss limits when deducted against earned income.

Typically most real estate professionals group their rentals together to eliminate the hourly requirement per property. However, if you had disallowed losses in prior years, you need to unbundle your grouping if you want to deduct those losses in the year of sale or disposal. This is a minor issue, and it requires a bit of mental gymnastics, but it should not dissuade you from electing real estate professional status and grouping your rentals.

Happy Investing!

Thanks,
Jason