The IRS has issued Revenue Procedure 2011-34, which allows qualified real estate professionals to make a late election to aggregate all their rental real estate interests as a single activity for purposes of meeting material participation under the passive activity loss rules.
In general, the election is made by filing a written statement with the taxpayer’s original income tax return. However, a taxpayer meeting certain specific requirements can now make a late election on an amended return and have it apply retroactively to a prior year.
In general, rental real estate is by definition a passive activity regardless of a taxpayer’s participation. However, this general rule does not apply to qualified real estate professionals. Real estate professionals that materially participate in rental real estate are allowed to deduct rental losses and recognize credits in full. For these taxpayers, the passive activity rules are applied as if each interest in rental real estate is a separate activity, unless the taxpayer elects to treat the taxpayer’s interests in rental real estate as one activity. Doing so can enable the taxpayer to deduct losses from a rental real estate activity not qualified as a separate activity, but qualified when aggregated with other rental real estate activities.
A qualified real estate professional needs to make the aggregation election by filing a written statement with their original income tax return for the first year in which the election is to apply. Once the election is made, it is binding on all future years until revoked or changed by the taxpayer, due to a material change in the taxpayer’s facts and circumstances. If this written statement is not filed, a taxpayer may not aggregate all their interests in rental real estate into a single activity. Many taxpayers have failed to file this required statement, and subsequently have lost the issue in court.
Previously, those taxpayers could obtain relief under the general standards for relief by:
- using the automatic six-month extension relief for a regulatory election, or
- requesting an extension of time relief for a regulatory election
The IRS has allowed many taxpayers to obtain relief under option 2, but it is possible that future relief will be more limited now that this Revenue Procedure is effective. It is possible, perhaps likely, that the IRS may disallow previously-deducted rental losses for taxpayers that do not file the aggregation election under this new Revenue Procedure.
New limited relief option
Under Revenue Procedure 2011-34, taxpayers are now eligible for relief if they meet specific requirements for making the late written election. In general, eligible taxpayers are those who failed to include the written election, but prepared their income tax returns as if the written election had been filed. Eligible taxpayers will need to follow certain procedural requirements outlined in the Revenue Procedure. These requirements are extensive, but the cost of making the late election likely is much less than the cost of an IRS exam, back taxes, and potential penalties and interest.
Taxpayers are advised to discuss this revenue procedure with a tax advisor that is knowledgeable about the aggregation election, your specific facts to determine if you are eligible for the new relief, when you are eligible for relief, and whether making such late election is beneficial in your specific circumstances.