Real Estate Aggregation Election – You Need to Know This

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There is a little known trick that IRS auditors are using right now during audits of real estate investors. If you’re a real estate investor, plan to be one or know someone who is, please pay special attention to this blog today. If you make the wrong choice, you could give up the ability to take thousands, maybe tens of thousands of dollars of deductions.

Let’s back up for a minute and talk about real estate tax losses. One of the great things about real estate is that you can have cash flow you put in your pocket and yet show a real loss on paper. That’s because of depreciation. And, at least through 2013, we had the ability to manipulate depreciation to create just as much of a loss as you want. (Well, pretty much)

The trick though is taking that tax loss against your other income. If you make less than $100,000 in adjusted gross income (AGI), you can take up to $25,000 in real estate loss against your income. Make more than $150K and you can’t deduction anything. Between $100K and $150K, the amount you can deduct phases out.

That is unless you’re a real estate professional. If you’re a real estate professional (using the IRS’s definition) you can deduct all of your tax loss against your income.

There are three steps to proving you’re a real estate professional. I’ve done 60 min webinars just on this topic, so please realize this is a really brief explanation.

  1. You or your spouse need to get 750 hours of real estate activity and more than any other trade or business, AND
  2. You must materially participate in the property (7 different ways you can do that – bottomline, spend a lot of hands on activity), AND
  3. You must qualify for each property individually or you can aggregate.

That leads us to the question from the reader:

“I am being audited for my real estate properties. I have 8 and manage 3 myself. The auditor told me that I should have elect to aggregate my properties. This is the first I heard of this and I have been claiming losses on my properties. Is it to late to submit logs while being audited?”

The reader is definitely clear on the issue. He needs to show logs that demonstrate he’s got the hours he needs to for the material participation per property. If he doesn’t, he’ll lose the deduction. Of course, as the auditor suggests, he could aggregate.

There is a problem though.

If you aggregate properties so that you only have to meet one material participation test (instead of one for each), if you sell a property at a loss you can’t take that loss against your other income. Instead the property loss is ‘stuck’ inside that aggregated group until you sell all the properties or use up the loss against other income.

The best answer is to prove material participation for each property and avoid having to aggregate. As far as whether it’s possible to now submit journals, I really don’t know because I don’t know where you are in the audit. If you haven’t gotten the final report, then yes you can submit them. If you are in the review period, you can ask to speak to a supervisor and submit them then. Or you can appeal. If you’ve passed those time frames, it’s still possible to appeal to Tax Court, but you will need an attorney and that will be much more expensive.

That’s one big reason why we recommend that you always use a tax professional for IRS representation. There is a strategy going into the audit so you (or your rep) is controlling the audit. If there is a fight, have it at a low level, not a high, so your rep costs are much lower.

The main thing is that you have to bring in a rep as soon as possible. That’s when we can do our best work and turn a possible big problem into a small one.

One Comment

  1. Joseph Heiser says:

    The article above states if you aggregate and you sell one prop. at a loss, you can’t take the loss against other income. Instead your stuck until you sell all your properties or use up the loss against other income. You just said you couldn’t use the loss against other income, so what other income are you referring to when you say “or use up the loss against other income”?

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