Rules for Certain Rental Real Estate Activities

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