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Jason M. Tyra, CPA
Jason M. Tyra, CPA, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 177
Experience:  Principal at Jason M. Tyra, CPA, PLLC
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What are the pros and cons of electing real estate activity

Customer Question

What are the pros and cons of electing real estate activity grouping under irc Section 469? I have short term vacation rentals and one long term house, all owned by me and managed by my 2 single person llcs. I don't have losses but I m considering filing the election to group them together (and managing them under one llc too) so the long term property would not have to meet the separate material participation and hours requirement of a real estate professional and be part of the family business of property management. One reason I want to do this is because the assets of or relating to the family business would be disregarded as I understand it for FAFSA. I want to make sure I have that correct and need to do that for FAFSA to disregard the value of the asset, and to know what the cons are of declaring this election to group the property as a single activity together?
Submitted: 6 months ago.
Category: Tax
Expert:  Jason M. Tyra, CPA replied 6 months ago.
Hi There:In this context, each property is treated as a separate activity by the IRS for the material participation rules. Any property for which you don't meet both the material and active participation rules is treated as passive. However, you can elect to aggregate the activities if they meet the material participation standard on a collective basis.
Expert:  Jason M. Tyra, CPA replied 6 months ago.
Whether you should do this depends on the effect you would like to see on your tax return. You may need to have some passive income in order to take passive losses from other investments, for example.
Expert:  Jason M. Tyra, CPA replied 6 months ago.
This election would not alter the manner in which the properties are treated under the financial aid rules. The only thing this election changes is the character of the income and expenses thrown off by the assets.
Customer: replied 6 months ago.

I replied to you but don't think you got it for some reason. I don't have losses but I did read in several places that" for FAFSA, rental properties are normally considered investments, not businesses, unless they are part of a formally recognized business that provides additional services.." and this election (and it would meet the nexus test) would make the long term rental part of the property management and rental business and for all intents and purposes be treated as one activity, one non passive business. Why do you say it does not alter how the properties are treated for financial aid ? Also someone mentioned in passing there are cons to making this election - but didn't say what they were so what are the cons?

Expert:  Jason M. Tyra, CPA replied 6 months ago.
The drawback to the election to aggregate would depend on the tax effect you are trying to create. For example, if you have substantial gains from an unrelated passive activity and losses from your properties, aggregating them to change their income from passive to non-passive would stop you from offsetting the gains and losses against each other.
Expert:  Jason M. Tyra, CPA replied 6 months ago.
Changing the character of the income stream would not cause your rental properties to meet the other criteria that you mentioned- that they be a "formally recognized business that provides additional services" unless you actually do provide services unrelated to managing the properties themselves.
Customer: replied 6 months ago.

Do you know where a case has discussed this ? because I think that one can make a case that they are all considered under the same family rental business if aggregated and the irs agrees to it or doesn't oppose it. Also how would substantial gains from a passive property offset the losses of an active one? please explain this a little more( and right now I have never had losses knock on wood) also can't I ungroup them in another tax year if I wanted to?

Expert:  Jason M. Tyra, CPA replied 6 months ago.
You may revoke the election if there is a material change in your circumstances, but not solely for the purpose avoiding tax.Consider the following: let's say you are a limited partner in company. You are allocated a loss on a K-1. This loss would be passive, since you are a limited partner. You also have gains on real property, which would also be passive because that is how real property gains and losses are treated by default. You can offset your gains on the property against your losses on the K-1, since both are passive. In that same year, if you elected to aggregate, thus changing the character of the real property losses to non-passive, your K-1 loss would be suspended. You would derive no benefit from it in that year, assuming you had no other passive income to use.
Expert:  Jason M. Tyra, CPA replied 6 months ago.
That's why I said that this may or may not work for you. It depends on what you're trying to do.The election to aggregate is for the purpose of changing passive income to non-passive income. In the context of a FAFSA, the character of the income under IRS rules does not automatically qualify or disqualify an activity for the family small business rules, since character of income is not a material factor. Under Deperatment of Education rules, real property rentals are treated as investments unless they do something else that would make them a business.
Expert:  Jason M. Tyra, CPA replied 6 months ago.
I can't cite any case law for this- it's not really something that goes to court.
Expert:  Jason M. Tyra, CPA replied 6 months ago.
So, the bot***** *****ne is that the Department of Education won't care that all of your rentals are lumped together. They will still be considered investments unless they also provide services.
Customer: replied 6 months ago.

I still don't understand what that all means. I thought passive is always bad when it comes to losses because it limits the amount. Not sure what you meant by gains or the treatment of it being balanced. Also I found this -

he small business exclusion was established by section 8019(c) of the Higher Education Reconciliation Act of 2005 (HERA 2005) as part of the Deficit Reduction Act of 2005 (P.L. 109-171, February 8, 2006). The specific amendment is as follows:

(c) TREATMENT OF FAMILY OWNERSHIP OF SMALL BUSINESSES. -- Section 480(f)(2) (20 U.S.C. 1087vv(f)(2)) is amended --

  1. in subparagraph (A), by striking "or";

  2. in subparagraph (B), by striking the period at the end and inserting "; or"; and

  3. by adding at the end the following new subparagraph:

    "(C) a small business with not more than 100 full-time or full-time equivalent employees (or any part of such a small business) that is owned and controlled by the family.".

After this amendment is applied to section 480(f)(2) of the Higher Education Act of 1965, the legislative language becomes:

With respect to determinations of need under this title, other than for subpart 4 of part A, the term "assets" shall not include the net value of --

  1. the family's principal place of residence; or

  2. a family farm on which the family resides.

  3. a small business with not more than 100 full-time or full-time equivalent employees (or any part of such a small business) that is owned and controlled by the family.


If the family owns multiple rental properties and materially participates in the management of the properties, they are more likely to be considered business assets.

Expert:  Jason M. Tyra, CPA replied 6 months ago.
Notice that it doesn't say "if the properties are aggregated for tax purposes." That election is not related to treatment on the FAFSA.
Expert:  Jason M. Tyra, CPA replied 6 months ago.
I can tell that I'm doing a bad job of explaining my answers to your questions, so I am going to opt out to give someone else an opportunity to help you.
Customer: replied 6 months ago.

Ok that would be ok and yes that was quoted from a FAFSA article on a financial aid website. Also maybe I don't even have to get that election to consider having materially participated with other factors and still have the asset excluded as part of the family business.

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