The IRS’s Limited-time Offer: Regrouping Real Estate Activities & Potential Tax Benefits

July 7, 2014

Under the new Section 1411, regrouping real estate activities can provide potential tax benefits, but timing is crucial for considering this opportunity. Taxpayers who have rental real estate activities that may be subject to the 3.8% net investment income tax (the "NII Tax") under Section 1411 should be mindful of a limited opportunity to regroup activities under the passive activity loss rules of Section 469 (the "PAL Rules"). In the case of individuals, trusts, and closely held corporations, the PAL Rules limit the use of losses from passive activities in which the taxpayer does not "materially participate," against active business income and investment income. Taxpayers are allowed to group activities, though only for purposes of determining whether they materially participate in those activities. Taxpayers have significant discretion in how they group activities, and proper grouping can ameliorate the impact of the PAL Rules significantly. However, once a taxpayer has determined how he or she will group activities, he or she is required to be consistent and group the activities in the same manner in future years.

The NII Tax, which went into effect in 2013, incorporates significant portions of the PAL Rules. Significantly, a taxpayer has to group activities for purposes of the NII Tax in the same manner as he or she groups activities for purposes of the PAL Rules. In some cases, decisions made years ago regarding whether to group activities and which activities to group, might have been beneficial under the PAL Rules but might be less attractive following the enactment of the NII tax. In recognition of this fact, the IRS has provided for a "fresh start" under the consistency rules for taxpayers that are subject to NII Tax. Such taxpayers are allowed a one-time option to regroup their activities. Regrouping must be made in the first taxable year beginning after December 31, 2013 in which NII Tax applies to the taxpayer, and the regroupings will apply for purposes of both the PAL Rules and the NII Tax. For calendar-year taxpayers that are subject to Section 1411, the regrouping must be determined on their calendar-year 2014 tax returns.