In the previous blog, we discussed how the Affordable Care Act has created a 3.8% surtax on investment income. To avoid the 3.8% surtax, investment income must be offset with investment losses or your income has to be considered non-passive. A rental property investor may achieve non-passive treatment through electing to be treated as a real estate professional.
Once it is determined that a taxpayer qualifies as a real estate professional, the non-passive treatment is available only for rental real estate activities in which the real estate professional materially participates. See previous blog for material participation.
A Real Estate Professional can elect to treat all interest (including limited partner interests) in rental real estate activities as a single activity. This election can be made in any year the special real estate professional rules apply. However, once the election is made, it is irrevocable unless there is a material change in the taxpayer’s facts and circumstances.
Material participation is determined for the combined activity as a whole when the election is made. The election to combine rental real estate activities may be crucial in allowing some taxpayers to meet the material participation tests or to meet the real estate professional requirements.
If the election is made, the combined rental real estate activity is treated as a single activity for all purposes including the disposition rules. Thus, suspended losses generally cannot be deducted until all (or substantially all) of the activities have been disposed of.
Also, if the election is made and 10% or more of the taxpayer’s share of gross receipts from rental real estate activities comes from limited partner interests, the combined activity is treated as a limited partner interest. The limited partner participation tests are more difficult to pass than the regular material participation tests.
If the taxpayer had net income from rental real estate activities in which he or she does not materially participate, keeping the passive status for those activities will allow that passive income to offset other passive losses. However, if the election is made, and he or she materially participates in the combined group, the net income or loss from the combined group is non-passive.
The decision to make the election will need to be made on a case-by-case basis. Contact your Anders advisor for further guidance.