[Federal Register Volume 60, Number 246 (Friday, December 22, 1995)]
[Rules and Regulations]
[Pages 66496-66502]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-30872]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8645]
RIN 1545-AS38
Rules for Certain Rental Real Estate Activities
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations providing rules for
rental real estate activities of taxpayers engaged in certain real
property trades or businesses. The regulations reflect changes to the
law made by the Omnibus Budget Reconciliation Act of 1993, and affect
taxpayers subject to the limitations on passive activity losses and
passive activity credits.
DATES: These regulations are effective on January 1, 1995. See
Sec. 1.469-11 for applicability.
ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (TD 8645), room 5228,
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,
DC 20044. In the alternative, submissions may be hand delivered between
the hours of 8:00 a.m. and 5:00 p.m. to: CC:DOM:CORP:T:R (TD 8645),
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW,
Washington, DC.
FOR FURTHER INFORMATION CONTACT: William M. Kostak at (202) 622-3080
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in these final regulations
has been reviewed and approved by the Office of Management and Budget
in accordance with the Paperwork Reduction Act (44 U.S.C. 3504(h))
under control number 1545-AS38. The estimated annual burden per
respondent varies from 0.10 hours to 0.25 hours, depending on
individual circumstances, with an estimated average of 0.15 hours.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, PC:FP,
Washington, DC 20224, and to the Office of Management and Budget, Attn:
Desk Officer for the Department of the Treasury, Office of Information
and Regulatory Affairs, Washington, DC 20503.
Background
This document amends 26 CFR part 1 to provide rules relating to the
treatment of rental real estate activities of certain taxpayers under
the passive activity loss and credit limitations of section 469.
Section 469 disallows losses from passive activities to the extent they
exceed income from passive activities and similarly disallows credits
from passive activities to the extent they exceed tax liability
allocable to passive activities. In general, passive activities are
activities in which the taxpayer does not materially participate. In
addition, until the enactment of the Omnibus Budget Reconciliation Act
of 1993 (OBRA 1993), all rental activities (including those in which a
taxpayer materially participated) were passive.
OBRA 1993 added section 469(c)(7), which provides that rental real
estate activities of qualifying taxpayers are not subject to the rule
that treats all rental activities as passive. Thus, a rental real
estate activity of a qualifying taxpayer is not passive if the taxpayer
materially participates in the activity. Further, section 469(c)(7)
provides that each of a qualifying taxpayer's interests in rental real
estate is treated as a separate activity unless the taxpayer elects to
treat all interests in rental real estate as a single activity.
On January 10, 1995, the IRS published in the Federal Register a
notice of proposed rulemaking (60 FR 2557) to provide guidance
regarding section 469(c)(7). A number of public comments were received
concerning the proposed regulations, and a public hearing was held on
May 11, 1995. After consideration of the comments received, the
proposed regulations are adopted as revised by this Treasury decision.
Explanation of Provisions
I. General Background
The proposed regulations provide rules for determining whether a
taxpayer qualifies for treatment under section 469(c)(7). The proposed
regulations also provide rules for determining the rental real estate
activities of qualifying taxpayers for purposes of section 469. Except
for modifications in response to comments received on the proposed
regulations,
[[Page 66497]]
the final regulations generally adopt the rules contained in the
proposed regulations.
II. Public Comments
Several comments requested that the Service reconsider the rule in
the proposed regulations prohibiting qualifying taxpayers from grouping
rental real estate activities with other activities in determining
whether the taxpayers materially participate in the rental real estate
activities. After careful consideration, the final regulations adopt
the rule in the proposed regulations because that position is
consistent with the statutory language and the legislative history.
Several comments suggested that the rule in the proposed
regulations prohibiting the grouping of rental real estate activities
with other activities be modified to allow qualifying taxpayers to
group the activities of development or construction of rental real
estate with rental real estate activities. The final regulations do not
adopt this modification because in most cases development and
construction activities are separate and distinct from rental
activities. In addition, this modification would introduce significant
administrative difficulties in determining which development activities
or construction activities qualify. However, the IRS and Treasury
Department invite comments concerning whether the material
participation tests in Sec. 1.469-5T(a) should be amended to include a
look-back material participation test for taxpayers significantly
involved in the development or construction of their rental real estate
interests.
Several comments requested clarification regarding whether a
qualifying taxpayer's participation in a management activity may count
towards material participation in a rental real estate activity if the
management activity includes the management of rental real estate owned
by the taxpayer. The final regulations clarify that a qualifying
taxpayer may participate in a rental real estate activity through
participation in a management activity. In determining whether the
taxpayer materially participates in the rental real estate activity,
however, work the taxpayer performs in the management activity is taken
into account only to the extent it is performed in managing the
taxpayer's own rental real estate. The final regulations also clarify
that a qualifying taxpayer who owns rental real estate through an
entity, including a C corporation that is subject to section 469, may
count work performed by the taxpayer in managing the rental real estate
of the entity in establishing material participation in the taxpayer's
rental real estate activities. Thus, if a qualifying taxpayer owns some
interests in rental real estate through a closely held C corporation
and makes the election to treat all interests in rental real estate as
a single activity, the aggregate rental real estate activity will
include those interests held through the closely held C corporation for
purposes of material participation.
One comment requested that the regulations modify the definition of
trade or business to clarify that a taxpayer's real property trades or
businesses are determined without regard to the taxpayer's grouping of
activities under Sec. 1.469-4. The final regulations clarify that a
taxpayer's grouping of activities under Sec. 1.469-4 does not control
the determination of the taxpayer's real property trades or businesses
for purposes of this section.
Several comments requested that the regulations provide a detailed
definition of real property trades or businesses beyond the cross-
reference to section 469(c)(7)(C). However, to avoid complex and
mechanical rules, the final regulations do not adopt a detailed
definition of real property trades or businesses. Instead, the
regulations provide that taxpayers may use any reasonable method for
determining their real property trades or businesses.
Several comments requested that the final regulations modify the
rule in the proposed regulations providing that only employees who are
five-percent owners of their employer at all times during the taxable
year may treat personal services performed as an employee as services
performed in a real property trade or business. The comments suggested
that the regulations should take into account personal services
performed by employees that are five-percent owners for a significant
portion of a taxable year. In response to these comments, the final
regulations are modified to provide that an employee may count services
performed in a real property trade or business during the portion of
the taxable year that the employee is a five-percent owner in the
employer.
Several comments requested clarification concerning whether a
qualifying taxpayer that makes an election to treat all interests in
rental real estate as a single activity will be treated as having a
single rental real estate activity for purposes of the former passive
activity rule under section 469 (f). In addition, comments requested
that the regulations be modified to provide that qualifying taxpayers
that make the aggregation election will be treated as having separate
activities for purposes of the disposition rules under section 469(g)
and Sec. 1.469-4(g). In response to these comments, the final
regulations clarify that a qualifying taxpayer that makes the election
to treat all interests in rental real estate as a single rental real
estate activity will be treated as having a single activity for all
purposes of section 469, including sections 469(f) and (g). The
statutory language and the legislative history do not support a rule
allowing a qualifying taxpayer to treat all interests in rental real
estate as a single activity for purposes of material participation and
section 469(f), but as separate activities for purposes of section
469(g).
In addition, in response to comments, the final regulations provide
an example illustrating the operation of the former passive activity
rule for qualifying taxpayers that make the election to treat all
interests in rental real estate as a single activity. This example
illustrates that qualifying taxpayers that make the aggregation
election may use current net income from the aggregate rental real
estate activity to offset the prior-year disallowed passive losses of
the aggregate rental real estate activity, regardless of which rental
real estate interests within that activity produced the income or
prior-year losses.
Some comments requested that the regulations permit qualifying
taxpayers to make or revoke the aggregation election on an amended
income tax return. After careful consideration of this issue, the final
regulations adopt the rule in the proposed regulations that aggregation
elections must be made or revoked on an original return. The final
regulations provide, however, that the election may be revoked in any
year in which the facts are materially changed from those in the
taxable year for which the election was made.
In addition, one comment requested clarification as to what
constitutes a material change in the facts and circumstances that would
allow a taxpayer to revoke an aggregation election. However, the final
regulations do not provide an example or bright-line rule for
determining when a material change in the facts and circumstances has
occurred, because this determination is intended to be a broad factual
inquiry. Providing an example or bright-line rule may inappropriately
restrict the scope of that inquiry.
One comment requested the modification of the rule in the proposed
regulations that the aggregation election has no effect in years the
taxpayer is not a qualifying taxpayer. Instead, the comment suggested
that, for ease of administration and compliance, the
[[Page 66498]]
aggregation election should be binding and irrevocable for all future
years, including years in which the taxpayer is not a qualifying
taxpayer. However, the final regulations adopt the rule in the proposed
regulations because the position advocated by the comment would be
unfavorable to many taxpayers and would not significantly improve
administration.
Several comments requested that the regulations modify the rule in
the proposed regulations treating each rental real estate interest of a
passthrough entity as a separate interest of a person owning a fifty-
percent or greater interest in the capital, gain, loss, income,
deduction, or credit of the entity at any time during a taxable year. A
commentator stated that this rule is burdensome on many passthrough
entities and should be eliminated or modified. The final regulations
modify this rule so that it applies only when a qualifying taxpayer
owns a fifty-percent or greater interest in the capital, profits, or
losses of a passthrough entity for a taxable year. Accordingly, this
rule will not apply if a qualifying taxpayer owns a fifty-percent or
greater interest in a single item of income or deduction but does not
own a fifty-percent or greater interest in the overall capital,
profits, or losses of the passthrough entity.
In response to one comment, the final regulations also clarify the
application of the fifty-percent ownership rule to tiered passthrough
entities. The final regulations provide that if a passthrough entity
owns a fifty-percent or greater interest in the capital, profits, or
losses of another passthrough entity for a taxable year, each interest
in rental real estate of the lower-tier entity will be a separate
interest in rental real estate of the upper-tier entity.
In response to another comment, the final regulations clarify that
section 469(i) applies after the rules of section 469(c)(7) are
applied. Accordingly, the $25,000 offset will be applied only against
passive losses from rental real estate activities, and not against
losses that are allowable as a result of section 469(c)(7). In
addition, the final regulations clarify that adjusted gross income for
purposes of section 469(i) is not reduced by any losses from rental
real estate that are allowable as a result of section 469(c)(7).
Several comments requested a modification to the effective date
provision, to provide that aggregation elections made for taxable years
beginning before January 1, 1995, are not binding for future years.
Because taxpayers had sufficient notice of the rules of section
469(c)(7) and these regulations, this modification is unnecessary and
would add administrative complexity. Accordingly, the final regulations
adopt the effective date provision of the proposed regulations.
Finally, in response to a comment, the activity regrouping rule of
Sec. 1.469-4(e)(2) is clarified to provide that a taxpayer may not
regroup activities unless the taxpayer's original grouping was clearly
inappropriate or there has been a material change in the facts and
circumstances that makes the original grouping clearly inappropriate.
III. Effective Dates
In general, section 469(c)(7) applies for taxable years beginning
after December 31, 1993. These regulations are effective for taxable
years beginning on or after January 1, 1995. These regulations are also
effective for elections under section 469(c)(7)(A) and paragraph (g) of
these regulations that are made with returns filed on or after January
1, 1995.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to
these regulations, and, therefore, a Regulatory Flexibility Analysis is
not required. Pursuant to section 7805(f) of the Internal Revenue Code,
the notice of proposed rulemaking preceding these regulations was
submitted to the Small Business Administration for comment on its
impact on small business.
Drafting Information
The principal author of these regulations is William M. Kostak,
Office of Assistant Chief Counsel (Passthroughs and Special
Industries), IRS. However, other personnel from the IRS and Treasury
Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
an entry in numerical order to read as follows:
Authority: 26 U.S.C. 7805. * * *
Section 1.469-9 also issued under 26 U.S.C. 469(c)(6), (h)(2),
and (l)(1).
Par. 2. Section 1.469-0 is amended by:
1. Revising the entry for Sec. 1.469-4(h).
2. Revising the heading for Sec. 1.469-9 and adding entries for
paragraphs (a) through (j) of Sec. 1.469-9.
3. Revising the entry for Sec. 1.469-11(b)(2) and removing the
entries for Sec. 1.469-11(b)(2)(i) and (ii).
4. Revising the entry for Sec. 1.469-11(b)(3).
5. Adding an entry for Sec. 1.469-11(b)(4).
6. The revisions and additions read as follows:
Sec. 1.469-0 Table of contents.
* * * * *
Sec. 1.469-4 Definition of Activity.
* * * * *
(h) Rules for grouping rental real estate activities for
taxpayers qualifying under section 469(c)(7).
* * * * *
Sec. 1.469-9 Rules for certain rental real estate activities.
(a) Scope and purpose.
(b) Definitions.
(1) Trade or business.
(2) Real property trade or business.
(3) Rental real estate.
(4) Personal services.
(5) Material participation.
(6) Qualifying taxpayer.
(c) Requirements for qualifying taxpayers.
(1) In general.
(2) Closely held C corporations.
(3) Requirement of material participation in the real property
trades or businesses.
(4) Treatment of spouses.
(5) Employees in real property trades or businesses.
(d) General rule for determining real property trades or
businesses.
(1) Facts and circumstances.
(2) Consistency requirement.
(e) Treatment of rental real estate activities of a qualifying
taxpayer.
(1) In general.
(2) Treatment as a former passive activity.
(3) Grouping rental real estate activities with other
activities.
(i) In general.
(ii) Special rule for certain management activities.
(4) Example.
(f) Limited partnership interests in rental real estate
activities.
(1) In general.
(2) De minimis exception.
(g) Election to treat all interests in rental real estate as a
single rental real estate activity.
(1) In general.
(2) Certain changes not material.
(3) Filing a statement to make or revoke the election.
(h) Interests in rental real estate held by certain passthrough
entities.
[[Page 66499]]
(1) General rule.
(2) Special rule if a qualifying taxpayer holds a fifty-percent
or greater interest in a passthrough entity.
(3) Special rule for interests held in tiered passthrough
entities.
(i) [Reserved].
(j) $25,000 offset for rental real estate activities of
qualifying taxpayers.
(1) In general.
(2) Example.
* * * * *
Sec. 1.469-11 Effective date and transition rules.
* * * * *
(b) * * *
(2) Additional transition rule for 1992 amendments.
(3) Fresh starts under consistency rules.
(i) Regrouping when tax liability is first determined under
Project PS-1-89.
(ii) Regrouping when tax liability is first determined under
Sec. 1.469-4.
(iii) Regrouping when taxpayer is first subject to section
469(c)(7).
(4) Certain investment credit property.
* * * * *
Par. 3. Section 1.469-4 is amended by revising paragraphs (e) (1)
and (2) and (h). The revisions read as follows:
Sec. 1.469-4 Definition of Activity.
* * * * *
(e) * * *
(1) Original groupings. Except as provided in paragraph (e)(2) of
this section and Sec. 1.469-11, once a taxpayer has grouped activities
under this section, the taxpayer may not regroup those activities in
subsequent taxable years. Taxpayers must comply with disclosure
requirements that the Commissioner may prescribe with respect to both
their original groupings and the addition and disposition of specific
activities within those chosen groupings in subsequent taxable years.
(2) Regroupings. If it is determined that a taxpayer's original
grouping was clearly inappropriate or a material change in the facts
and circumstances has occurred that makes the original grouping clearly
inappropriate, the taxpayer must regroup the activities and must comply
with disclosure requirements that the Commissioner may prescribe.
* * * * *
(h) Rules for grouping rental real estate activities for taxpayers
qualifying under section 469(c)(7). See Sec. 1.469-9 for rules for
certain rental real estate activities.
Par. 4. Section 1.469-9 is revised to read as follows:
Sec. 1.469-9 Rules for certain rental real estate activities.
(a) Scope and purpose. This section provides guidance to taxpayers
engaged in certain real property trades or businesses on applying
section 469(c)(7) to their rental real estate activities.
(b) Definitions. The following definitions apply for purposes of
this section:
(1) Trade or business. A trade or business is any trade or business
determined by treating the types of activities in Sec. 1.469-4(b)(1) as
if they involved the conduct of a trade or business, and any interest
in rental real estate, including any interest in rental real estate
that gives rise to deductions under section 212.
(2) Real property trade or business. Real property trade or
business is defined in section 469(c)(7)(C).
(3) Rental real estate. Rental real estate is any real property
used by customers or held for use by customers in a rental activity
within the meaning of Sec. 1.469-1T(e)(3). However, any rental real
estate that the taxpayer grouped with a trade or business activity
under Sec. 1.469-4(d)(1)(i)(A) or (C) is not an interest in rental real
estate for purposes of this section.
(4) Personal services. Personal services means any work performed
by an individual in connection with a trade or business. However,
personal services do not include any work performed by an individual in
the individual's capacity as an investor as described in Sec. 1.469-
5T(f)(2)(ii).
(5) Material participation. Material participation has the same
meaning as under Sec. 1.469-5T. Paragraph (f) of this section contains
rules applicable to limited partnership interests in rental real estate
that a qualifying taxpayer elects to aggregate with other interests in
rental real estate of that taxpayer.
(6) Qualifying taxpayer. A qualifying taxpayer is a taxpayer that
owns at least one interest in rental real estate and meets the
requirements of paragraph (c) of this section.
(c) Requirements for qualifying taxpayers--(1) In general. A
qualifying taxpayer must meet the requirements of section 469(c)(7)(B).
(2) Closely held C corporations. A closely held C corporation meets
the requirements of paragraph (c)(1) of this section by satisfying the
requirements of section 469(c)(7)(D)(i). For purposes of section
469(c)(7)(D)(i), gross receipts do not include items of portfolio
income within the meaning of Sec. 1.469-2T(c)(3).
(3) Requirement of material participation in the real property
trades or businesses. A taxpayer must materially participate in a real
property trade or business in order for the personal services provided
by the taxpayer in that real property trade or business to count
towards meeting the requirements of paragraph (c)(1) of this section.
(4) Treatment of spouses. Spouses filing a joint return are
qualifying taxpayers only if one spouse separately satisfies both
requirements of section 469(c)(7)(B). In determining the real property
trades or businesses in which a married taxpayer materially
participates (but not for any other purpose under this paragraph (c)),
work performed by the taxpayer's spouse in a trade or business is
treated as work performed by the taxpayer under Sec. 1.469-5T(f)(3),
regardless of whether the spouses file a joint return for the year.
(5) Employees in real property trades or businesses. For purposes
of paragraph (c)(1) of this section, personal services performed during
a taxable year as an employee generally will be treated as performed in
a trade or business but will not be treated as performed in a real
property trade or business, unless the taxpayer is a five-percent owner
(within the meaning of section 416(i)(1)(B)) in the employer. If an
employee is not a five-percent owner in the employer at all times
during the taxable year, only the personal services performed by the
employee during the period the employee is a five-percent owner in the
employer will be treated as performed in a real property trade or
business.
(d) General rule for determining real property trades or
businesses--(1) Facts and circumstances. The determination of a
taxpayer's real property trades or businesses for purposes of paragraph
(c) of this section is based on all of the relevant facts and
circumstances. A taxpayer may use any reasonable method of applying the
facts and circumstances in determining the real property trades or
businesses in which the taxpayer provides personal services. Depending
on the facts and circumstances, a real property trade or business
consists either of one or more than one trade or business specifically
described in section 469(c)(7)(C). A taxpayer's grouping of activities
under Sec. 1.469-4 does not control the determination of the taxpayer's
real property trades or businesses under this paragraph (d).
(2) Consistency requirement. Once a taxpayer determines the real
property trades or businesses in which personal services are provided
for purposes of paragraph (c) of this section, the taxpayer may not
redetermine those real property trades or businesses in subsequent
taxable years unless the original determination was clearly
inappropriate or there has been a material change in the facts and
[[Page 66500]]
circumstances that makes the original determination clearly
inappropriate.
(e) Treatment of rental real estate activities of a qualifying
taxpayer--(1) In general. Section 469(c)(2) does not apply to any
rental real estate activity of a taxpayer for a taxable year in which
the taxpayer is a qualifying taxpayer under paragraph (c) of this
section. Instead, a rental real estate activity of a qualifying
taxpayer is a passive activity under section 469 for the taxable year
unless the taxpayer materially participates in the activity. Each
interest in rental real estate of a qualifying taxpayer will be treated
as a separate rental real estate activity, unless the taxpayer makes an
election under paragraph (g) of this section to treat all interests in
rental real estate as a single rental real estate activity. Each
separate rental real estate activity, or the single combined rental
real estate activity if the taxpayer makes an election under paragraph
(g), will be an activity of the taxpayer for all purposes of section
469, including the former passive activity rules under section 469(f)
and the disposition rules under section 469(g). However, section 469
will continue to be applied separately with respect to each publicly
traded partnership, as required under section 469(k), notwithstanding
the rules of this section.
(2) Treatment as a former passive activity. For any taxable year in
which a qualifying taxpayer materially participates in a rental real
estate activity, that rental real estate activity will be treated as a
former passive activity under section 469(f) if disallowed deductions
or credits are allocated to the activity under Sec. 1.469-1(f)(4).
(3) Grouping rental real estate activities with other activities--
(i) In general. For purposes of this section, a qualifying taxpayer may
not group a rental real estate activity with any other activity of the
taxpayer. For example, if a qualifying taxpayer develops real property,
constructs buildings, and owns an interest in rental real estate, the
taxpayer's interest in rental real estate may not be grouped with the
taxpayer's development activity or construction activity. Thus, only
the participation of the taxpayer with respect to the rental real
estate may be used to determine if the taxpayer materially participates
in the rental real estate activity under Sec. 1.469-5T.
(ii) Special rule for certain management activities. A qualifying
taxpayer may participate in a rental real estate activity through
participation, within the meaning of Secs. 1.469-5(f) and 5T(f), in an
activity involving the management of rental real estate (even if this
management activity is conducted through a separate entity). In
determining whether the taxpayer materially participates in the rental
real estate activity, however, work the taxpayer performs in the
management activity is taken into account only to the extent it is
performed in managing the taxpayer's own rental real estate interests.
(4) Example. The following example illustrates the application of
this paragraph (e).
Example. (i) Taxpayer B owns interests in three rental
buildings, U, V and W. In 1995, B has $30,000 of disallowed passive
losses allocable to Building U and $10,000 of disallowed passive
losses allocable to Building V under Sec. 1.469-1(f)(4). In 1996, B
has $5,000 of net income from Building U, $5,000 of net losses from
Building V, and $10,000 of net income from Building W. Also in 1996,
B is a qualifying taxpayer within the meaning of paragraph (c) of
this section. Each building is treated as a separate activity of B
under paragraph (e)(1) of this section, unless B makes the election
under paragraph (g) to treat the three buildings as a single rental
real estate activity. If the buildings are treated as separate
activities, material participation is determined separately with
respect to each building. If B makes the election under paragraph
(g) to treat the buildings as a single activity, all participation
relating to the buildings is aggregated in determining whether B
materially participates in the combined activity.
(ii) Effective beginning in 1996, B makes the election under
paragraph (g) to treat the three buildings as a single rental real
estate activity. B works full-time managing the three buildings and
thus materially participates in the combined activity in 1996 (even
if B conducts this management function through a separate entity,
including a closely held C corporation). Accordingly, the combined
activity is not a passive activity of B in 1996. Moreover, as a
result of the election under paragraph (g), disallowed passive
losses of $40,000 ($30,000+$10,000) are allocated to the combined
activity. B's net income from the activity for 1996 is $10,000
($5,000-$5,000+$10,000). This net income is nonpassive income for
purposes of section 469. However, under section 469(f), the net
income from a former passive activity may be offset with the
disallowed passive losses from the same activity. Because Buildings
U, V and W are treated as one activity for all purposes of section
469 due to the election under paragraph (g), and this activity is a
former passive activity under section 469(f), B may offset the
$10,000 of net income from the buildings with an equal amount of
disallowed passive losses allocable to the buildings, regardless of
which buildings produced the income or losses. As a result, B has
$30,000 ($40,000-$10,000) of disallowed passive losses remaining
from the buildings after 1996.
(f) Limited partnership interests in rental real estate
activities--(1) In general. If a taxpayer elects under paragraph (g) of
this section to treat all interests in rental real estate as a single
rental real estate activity, and at least one interest in rental real
estate is held by the taxpayer as a limited partnership interest
(within the meaning of Sec. 1.469-5T(e)(3)), the combined rental real
estate activity will be treated as a limited partnership interest of
the taxpayer for purposes of determining material participation.
Accordingly, the taxpayer will not be treated under this section as
materially participating in the combined rental real estate activity
unless the taxpayer materially participates in the activity under the
tests listed in Sec. 1.469-5T(e)(2) (dealing with the tests for
determining the material participation of a limited partner).
(2) De minimis exception. If a qualifying taxpayer elects under
paragraph (g) of this section to treat all interests in rental real
estate as a single rental real estate activity, and the taxpayer's
share of gross rental income from all of the taxpayer's limited
partnership interests in rental real estate is less than ten percent of
the taxpayer's share of gross rental income from all of the taxpayer's
interests in rental real estate for the taxable year, paragraph (f)(1)
of this section does not apply. Thus the taxpayer may determine
material participation under any of the tests listed in Sec. 1.469-
5T(a) that apply to rental real estate activities.
(g) Election to treat all interests in rental real estate as a
single rental real estate activity--(1) In general. A qualifying
taxpayer may make an election to treat all of the taxpayer's interests
in rental real estate as a single rental real estate activity. This
election is binding for the taxable year in which it is made and for
all future years in which the taxpayer is a qualifying taxpayer under
paragraph (c) of this section, even if there are intervening years in
which the taxpayer is not a qualifying taxpayer. The election may be
made in any year in which the taxpayer is a qualifying taxpayer, and
the failure to make the election in one year does not preclude the
taxpayer from making the election in a subsequent year. In years in
which the taxpayer is not a qualifying taxpayer, the election will not
have effect and the taxpayer's activities will be those determined
under Sec. 1.469-4. If there is a material change in the taxpayer's
facts and circumstances, the taxpayer may revoke the election using the
procedure described in paragraph (g)(3) of this section.
(2) Certain changes not material. The fact that an election is less
advantageous to the taxpayer in a particular taxable year is not, of
itself, a material change
[[Page 66501]]
in the taxpayer's facts and circumstances. Similarly, a break in the
taxpayer's status as a qualifying taxpayer is not, of itself, a
material change in the taxpayer's facts and circumstances.
(3) Filing a statement to make or revoke the election. A qualifying
taxpayer makes the election to treat all interests in rental real
estate as a single rental real estate activity by filing a statement
with the taxpayer's original income tax return for the taxable year.
This statement must contain a declaration that the taxpayer is a
qualifying taxpayer for the taxable year and is making the election
pursuant to section 469(c)(7)(A). The taxpayer may make this election
for any taxable year in which section 469(c)(7) is applicable. A
taxpayer may revoke the election only in the taxable year in which a
material change in the taxpayer's facts and circumstances occurs or in
a subsequent year in which the facts and circumstances remain
materially changed from those in the taxable year for which the
election was made. To revoke the election, the taxpayer must file a
statement with the taxpayer's original income tax return for the year
of revocation. This statement must contain a declaration that the
taxpayer is revoking the election under section 469(c)(7)(A) and an
explanation of the nature of the material change.
(h) Interests in rental real estate held by certain passthrough
entities--(1) General rule. Except as provided in paragraph (h)(2) of
this section, a qualifying taxpayer's interest in rental real estate
held by a partnership or an S corporation (passthrough entity) is
treated as a single interest in rental real estate if the passthrough
entity grouped its rental real estate as one rental activity under
Sec. 1.469-4(d)(5). If the passthrough entity grouped its rental real
estate into separate rental activities under Sec. 1.469-4(d)(5), each
rental real estate activity of the passthrough entity will be treated
as a separate interest in rental real estate of the qualifying
taxpayer. However, the qualifying taxpayer may elect under paragraph
(g) of this section to treat all interests in rental real estate,
including the rental real estate interests held through passthrough
entities, as a single rental real estate activity.
(2) Special rule if a qualifying taxpayer holds a fifty-percent or
greater interest in a passthrough entity. If a qualifying taxpayer
owns, directly or indirectly, a fifty-percent or greater interest in
the capital, profits, or losses of a passthrough entity for a taxable
year, each interest in rental real estate held by the passthrough
entity will be treated as a separate interest in rental real estate of
the qualifying taxpayer, regardless of the passthrough entity's
grouping of activities under Sec. 1.469-4(d)(5). However, the
qualifying taxpayer may elect under paragraph (g) of this section to
treat all interests in rental real estate, including the rental real
estate interests held through passthrough entities, as a single rental
real estate activity.
(3) Special rule for interests held in tiered passthrough entities.
If a passthrough entity owns a fifty-percent or greater interest in the
capital, profits, or losses of another passthrough entity for a taxable
year, each interest in rental real estate held by the lower-tier entity
will be treated as a separate interest in rental real estate of the
upper-tier entity, regardless of the lower-tier entity's grouping of
activities under Sec. 1.469-4(d)(5).
(i) [Reserved].
(j) $25,000 offset for rental real estate activities of qualifying
taxpayers--(1) In general. A qualifying taxpayer's passive losses and
credits from rental real estate activities (including prior-year
disallowed passive activity losses and credits from rental real estate
activities in which the taxpayer materially participates) are allowed
to the extent permitted under section 469(i). The amount of losses or
credits allowable under section 469(i) is determined after the rules of
this section are applied. However, losses allowable by reason of this
section are not taken into account in determining adjusted gross income
for purposes of section 469(i)(3).
(2) Example. The following example illustrates the application of
this paragraph (j).
Example. (i) Taxpayer A owns building X and building Y, both
interests in rental real estate. In 1995, A is a qualifying taxpayer
within the meaning of paragraph (c) of this section. A does not
elect to treat X and Y as one activity under section 469(c)(7)(A)
and paragraph (g) of this section. As a result, X and Y are treated
as separate activities pursuant to section 469(c)(7)(A)(ii). A
materially participates in X which has $100,000 of passive losses
disallowed from prior years and produces $20,000 of losses in 1995.
A does not materially participate in Y which produces $40,000 of
income in 1995. A also has $50,000 of income from other nonpassive
sources in 1995. A otherwise meets the requirements of section
469(i).
(ii) Because X is not a passive activity in 1995, the $20,000 of
losses produced by X in 1995 are nonpassive losses that may be used
by A to offset part of the $50,000 of nonpassive income.
Accordingly, A is left with $30,000 ($50,000-$20,000) of nonpassive
income. In addition, A may use the prior year disallowed passive
losses of X to offset any income from X and passive income from
other sources. Therefore, A may offset the $40,000 of passive income
from Y with $40,000 of passive losses from X.
(iii) Because A has $60,000 ($100,000-$40,000) of passive losses
remaining from X and meets all of the requirements of section
469(i), A may offset up to $25,000 of nonpassive income with passive
losses from X pursuant to section 469(i). As a result, A has $5,000
($30,000-$25,000) of nonpassive income remaining and disallowed
passive losses from X of $35,000 ($60,000-$25,000) in 1995.
Par. 5. Section 1.469-11 is amended as follows:
1. Paragraph (a)(2) is amended by removing ``; and'' and adding
``;'' in its place.
2. Paragraph (a)(3) is redesignated as paragraph (a)(4) and a new
paragraph (a)(3) is added.
3. Paragraph (b)(1) is revised.
4. The heading for paragraph (b)(2) is revised; the headings for
paragraphs (b)(2)(i) and (b)(2)(ii) are removed; paragraph (b)(2)(ii)
is removed, and paragraph (b)(2)(i) is redesignated as paragraph
(b)(2).
5. Paragraph (b)(3) is redesignated as paragraph (b)(4).
6. A new paragraph (b)(3) is added.
The added and revised provisions read as follows:
Sec. 1.469-11 Effective date and transition rules.
(a) * * *
(3) The rules contained in Sec. 1.469-9 apply for taxable years
beginning on or after January 1, 1995, and to elections made under
Sec. 1.469-9(g) with returns filed on or after January 1, 1995; and
* * * * *
(b) * * * (1) Application of 1992 amendments for taxable years
beginning before October 4, 1994. Except as provided in paragraph
(b)(2) of this section, for taxable years that end after May 10, 1992,
and begin before October 4, 1994, a taxpayer may determine tax
liability in accordance with Project PS-1-89 published at 1992-1 C.B.
1219 (see Sec. 601.601(d)(2)(ii)(b) of this chapter).
(2) Additional transition rule for 1992 amendments. * * *
(3) Fresh starts under consistency rules--(i) Regrouping when tax
liability is first determined under Project PS-1-89. For the first
taxable year in which a taxpayer determines its tax liability under
Project PS-1-89, the taxpayer may regroup its activities without regard
to the manner in which the activities were grouped in the preceding
taxable year and must regroup its activities if the grouping in the
preceding taxable year is inconsistent with the rules of Project PS-1-
89.
(ii) Regrouping when tax liability is first determined under
Sec. 1.469-4. For the first taxable year in which a
[[Page 66502]]
taxpayer determines its tax liability under Sec. 1.469-4, rather than
under the rules of Project PS-1-89, the taxpayer may regroup its
activities without regard to the manner in which the activities were
grouped in the preceding taxable year and must regroup its activities
if the grouping in the preceding taxable year is inconsistent with the
rules of Sec. 1.469-4.
(iii) Regrouping when taxpayer is first subject to section
469(c)(7). For the first taxable year beginning after December 31,
1993, a taxpayer may regroup its activities to the extent necessary or
appropriate to avail itself of the provisions of section 469(c)(7) and
without regard to the manner in which the activities were grouped in
the preceding taxable year.
* * * * *
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved: December 12, 1995.
Leslie Samuels,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 95-30872 Filed 12-21-95; 8:45 am]
BILLING CODE 4830-01-U
