The tax community is still talking about Rev. Proc. 2011-34, a fairly recent tax ruling that allows real estate investors to make a ‘late election aggregation.’
On the surface, it looks like this is something great because it allows real estate professionals to fix a problem they may have had with failure to properly make an aggregation election on the return.
If you are a real estate professional, or think you might be, make sure you read this article. It could mean a tax problem or tax solution for you.
Let’s back up and take a look at the key issues and why this might not be such a great thing.
First of all, if you make less than $100,000 per year, you can take up to $25,000 of your real estate losses against other income. If you make over $150,000, you can’t take any of your real estate losses. Between $100,000 and the $150,000, the amount of the loss phases out.
If you make over $150,000, there is still a possible solution.
If you file as a real estate professional with material participation, you can take all of your real estate losses against your other income, no matter how much the losses are and no matter how much your income is.
The benefit is huge – you get to take losses, often phantom losses, against your other income. The problem is that qualification can be complicated and the IRS audit risk is huge.
We advise clients on how to safely take the real estate professional status. To date, none of our clients who have taken this status on any of the thousands of returns we done have been audited. But I’m not naïve enough to think that’s going to go on forever. However, I do know that we’re ready. Our clients know exactly what records they need to keep and we’re ready to assist in tax representation on this complicated issue right from the start.
That’s why we have been very slow to take advantage of the so-called benefit of Revenue Procedure 2011-34.
So, bear with me, as I go through a few more definitions:
A real estate professional, according to IRS guidelines, is someone who has at least 750 hours in real estate activities and at least as many hours in real estate activities as any other trade or business.
That’s the first part.
The second part is that you also need to have material participation. Tomorrow’s blog will go over what that means in more detail. On the blog for the day after tomorrow, I’ll tell you the mistakes the IRS is making in real estate investor audits and what you need to do about it.
The challenge for investors with multiple real estate properties is that they will need to meet the material participation rules per property. That can be hard if you have more than one property. So the way around it is to make an election on your return to “aggregate” properties. If you make that election, all of your properties will be treated as one group and that means you only need to meet the test for the group once.
There is a possible trap, however. If you later sell one of the properties at a loss, then the loss cannot be taken against other income. It’s held within the group until you sell all the properties. There’s another solution but you have to take action on that before you sell.
Now, here’s the trap. The IRS is now allowing real estate investors to make the aggregation election for past years. That sounds great for everyone who is worried that if they get an audit they might not be able to meet the criteria. But if you’ve had a loss on a property in a past year, you may end up suddenly having to pay a whole bunch in taxes.
Thoughtfully consider all of the ramifications before you make any type of election like this. Make sure your CPA understands real estate professional tax status, aggregation and sophisticated real estate tax planning. Otherwise, you could get caught paying tax needlessly.
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