The real estate professional grouping election: when Reg. 1.469-9(g) helps, when it hurts and how to make it

What is the grouping election under Reg. 1.469-9(g)?

It is an election, made once, to treat all of your interests in rental real estate as a single rental real estate activity. It is available only to a taxpayer who qualifies as a real estate professional under IRC §469(c)(7).

Without the election, each rental property is a separate activity for the passive loss rules. Treas. Reg. §1.469-9(g) changes that. The statute behind it is IRC §469(c)(7)(A). The general explanation of the passive rules is in IRS Publication 925.

If you are not sure you qualify as a real estate professional in the first place, start with the 750-hour test for real estate professional status. The election sits on top of that status. It does nothing without it.

Why would a real estate professional need it?

Because qualifying is only half the job. A real estate professional must still materially participate in each rental, and each rental is a separate activity unless you group them.

Material participation uses the tests in Temp. Treas. Reg. §1.469-5T(a). For a landlord, the common ones are 500 hours in the activity, or more than 100 hours and at least as many as anyone else. Those tests are hard to pass property by property when you own several rentals.

Picture a couple with five rentals. The qualifying spouse works 900 hours in real estate across all five. That is about 180 per property. Nobody hits 500 on any one rental. And if a property manager spends more hours on a property than the owner, the 100-hour test fails there too. Without the election, losses from most of those rentals stay passive.

With the election, all five are one activity. The 900 hours, plus any hours from the other spouse, are tested once. That is 500 or more, so the combined activity passes.

Does the election make me a real estate professional?

No. The election only changes how activities are grouped. You must still meet the 750-hour test and the more-than-half test every year.

IRS Chief Counsel said the same thing in CCA 201427016: whether you are a qualifying taxpayer is decided first, and it is not affected by the election. Chief Counsel advice cannot be cited as precedent, but it shows how the IRS reads the rule. Think of the election as a tool for people who are already on the right side of the line.

In a year you fail the status tests, Treas. Reg. §1.469-9(g)(1) says the election has no effect that year, and your rentals are passive under the normal rules. The election is not lost. It applies again in any later year you qualify.

When does the election help?

It helps when you qualify as a real estate professional but cannot pass material participation property by property.

• Thin hours per property. You split your time across several rentals and none reaches a test alone.
• A manager outworks you. A property manager has more hours than you on a given property, so the 100-hour test fails there.
• Net investment income tax exposure. Rental income can be subject to the 3.8 percent tax. The Treas. Reg. §1.1411-4(g)(7) safe harbor treats a real estate professional's rental income as trade or business income if you work more than 500 hours in the rental real estate activity, or did so in any 5 of the prior 10 years. The regulation says the grouping election also applies for this safe harbor, so hours across all your rentals count together. We check this case by case.
• Prior-year suspended losses. In the first year of the election, losses suspended from earlier years are allocated to the combined activity. They keep their status as prior-year passive losses, so they offset net income from the combined activity, or other passive income, not wages. The benefit is that income from any rental in the group can absorb them, not only income from the property that created them.

These are real benefits, but they come with commitments. Read the next section before deciding.

When can the election hurt?

It can hurt because it is hard to reverse, it ties your properties together and it changes what happens when you sell one.

• It is binding. The election applies for the year you make it and every later year you qualify, even after a gap. Treas. Reg. §1.469-9(g) allows revocation only when your facts and circumstances change materially, with a statement filed on the original return for the year of revocation that explains the change. The regulation says a year in which the election is less helpful, or a break in your real estate professional status, is not by itself a material change.
• Selling one property generally does not free its losses. With the election, the combined activity is the activity for the disposition rule in IRC §469(g), so suspended losses are released in full only when you dispose of your entire interest in it in a taxable sale. The partial disposition rule in Treas. Reg. §1.469-4(g) helps only when substantially all of an activity is sold and the losses can be traced. If you plan to sell a property soon, talk through the loss timing first.
• Limited partnership interests can taint the group. A limited partnership interest is treated differently for material participation. Under Treas. Reg. §1.469-9(f)(1), if you elect and hold at least one limited partnership interest in rental real estate, the whole combined activity is treated as a limited partnership interest. You can then use only 3 of the 7 material participation tests: more than 500 hours, 5 of the prior 10 years, or the personal service activity test. The de minimis exception in §1.469-9(f)(2) removes this problem if your share of gross rental income from limited partnership interests is less than 10 percent of your share of gross rental income from all your rental real estate. Review any partnership or fund interest before you elect.
• It is all or nothing. You cannot pick which properties to include. Properties you buy later join the group automatically.
• You still must qualify. If you miss the status tests in a later year, the combined activity is passive that year.

A sale is the situation most owners overlook. Before you list a property, run the numbers. If the plan involves a 1031 exchange, check how the exchange and the election interact. An exchange is not a fully taxable disposition, so it does not release suspended losses.

How and when do I make the election?

Attach a statement to your original, timely filed return for the first year you want it to apply. The statement must say you are a qualifying taxpayer and that you are making the election under §469(c)(7)(A).

The requirement is in Treas. Reg. §1.469-9(g)(3). The regulation does not prescribe a form or exact wording. It requires a statement filed with your original return that contains two things: a declaration that you are a qualifying taxpayer for the year, and a declaration that you are making the election under IRC §469(c)(7)(A). We draft the statement for each client so it covers both points.

A few practical points:

• Listing properties together on Schedule E is not an election. The statement is what counts.
• Do not re-elect every year. Once made, it continues. You do need to retest your real estate professional status every year.
• Confirm the statement is in the e-file attachments before transmitting the return.
• Keep a copy of the filed statement with your permanent tax records.
• Check prior returns first. If an election was already made, a second statement is not needed.
• Keep nonpassive rentals off Form 8582 and use the right Schedule E reporting for the combined activity.

Because the statement goes on the original return, the decision has to be made before you file. If you extend, the extended original return still works. An amended return is not the normal route, other than the late relief below.

What if I missed the election?

Rev. Proc. 2011-34 lets some taxpayers make a late election by filing an amended return, with no private letter ruling and no user fee, if they meet its conditions.

You must state, under penalties of perjury, that all four of these are true:

• You failed to make the election only because you did not timely meet the requirements of the regulation, such as filing the statement.
• You filed consistently with having made the election on every return that would have been affected, for the election year and every later year, and no return took an inconsistent position.
• You timely filed each return that would have been affected. A return filed within 6 months after its due date, not counting extensions, is treated as timely.
• You had reasonable cause for missing the election.

The statement required by Treas. Reg. §1.469-9(g)(3) goes with an amended return for the most recent tax year, mailed to the IRS service center where you file your current return. The statement must explain why the election was late, include the representations above, name the year the election should start and say at the top "FILED PURSUANT TO REV. PROC. 2011-34." It must be signed and dated with the penalties of perjury declaration the revenue procedure provides. If you do not qualify for this relief, the remaining route is a private letter ruling. The relief also does not decide whether you were actually a real estate professional or materially participated. Those still have to be true on the facts. If you think you missed an election in a past year, ask us to review it before you file anything.

Do short-term rentals go into the group?

No. A short-term rental with an average stay of 7 days or less is not a rental activity under the passive loss rules, so it does not belong in the rental real estate group.

The same is true of a rental with an average stay of 30 days or less where significant personal services are provided. Each short-term rental is tested on its own, or grouped with other activities as a trade or business under Treas. Reg. §1.469-4 where the facts support it. The rules are in Temp. Treas. Reg. §1.469-1T(e)(3). See short-term rental material participation hours for the hours tests, and short-term rental vs long-term rental taxes for a side-by-side comparison with long-term rentals.

Next step

If you own several long-term rentals and one spouse might qualify as a real estate professional, our page for real estate investors explains how we plan and file. If you own short-term rentals, the STR Tax Advantage Plan is built for you and starts at $4,997 one time. Either way, you can start with a free discovery call.