PY Unallowed Passive Losses to Offset Income on Second Rental

[arttax]

Hello all!

First and foremost, thank you in advance for your advice! A little confused by something and hope someone can shed some light on this for me:

I have a client who is a real estate professional. Primary business is RE sales. Client also owns two income-producing properties - a commercial building and a vacation rental. Both properties are reported on the same schedule E, though the commercial building is held by a disregarded LLC.

Client has made election 469(c)(7)(A) to group all rental activities, and client meets both material and active participation standards.

This year, client's commercial building netted $35k, but vacation rental netted a $65k loss. In aggregate, loss is ~$29k. The vacation rental has a PY unallowed PAL of $35k. Given that commercial building had income of $35k, can I apply a PY unallowed PAL from the vacation rental, thus increasing aggregate loss to ~$64k?

Thank you again for taking time to read through this! I appreciate you!

[BobKamman]

I'm sure you're not a DIY taxpayer or a student working on a midterm. But this question sure has a funny smell.  

[arttax]

Bob,

No, I'm not a DIY taxpayer, nor am I a student. It's a complicated situation that I haven't dealt with before, and I'm genuinely looking for guidance. I've read through 469 and the IRS PAL guide like a good tax preparer, but I can't seem to find anything concrete. If you have any advice, I'd appreciate it. 

[TaxGuyBill · Accepted solution]

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@arttax wrote:

Client has made election 469(c)(7)(A) to group all rental activities

This year, client's commercial building netted $35k, but vacation rental netted a $65k loss. In aggregate, loss is ~$29k.

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The grouped "rental activity" has a $29,000 loss for the year.  That doesn't allow for a carryover loss to be used.

As a side note, you may want to verify that the carryover loss is valid.  You would want to verify that it was created BEFORE the taxpayer qualified under the Real Estate Professional rules, and that there hasn't been net income since becoming a real estate professional qualifications.

[arttax]

This was my thinking, as well. Client was insisting that the loss was useable, which didn't make sense given that Sch E showed a net loss. Much obliged for the response, Bill!

[BobKamman]

@TaxGuyBill  

Yes, that carryover loss is the fly in the ointment (or the way to earn extra credit on the exam question). The taxpayer only became a “real estate professional” this year when he bought the commercial building? But the post says the election to group activities has already been made. We’re back to playing “I’ve Got A Secret” about what happened last year.

And exactly what is the “vacation rental”? Is this an Airbnb, or is it a place at the lake that is rented out when the family isn’t using it? There is some interesting material in the IRS Audit Manual about vacation rentals – I’m not sure I agree with the 7-day test, but I haven’t had to research it for my own clients.

“Activities with an average rental period of 7 days or less are defined as businesses, not rentals. Therefore, the active participation standard and the $25,000 rental real estate allowance do not apply to these types of activities. Losses, if passive, go on Form 8582 line 3b, not 1b.

• The personal use rules IRC § 280A take precedence over IRC § 469. If the taxpayer or family members spent more than 14 days at the property, losses generally are not allowed under the rules in IRC § 280A. The losses do not enter into the passive activity computation and should not be
entered on Form 8582.”

https://www.irs.gov/pub/irs-mssp/pal.pdf 

[arttax]

@BobKamman, it takes a rare breed to make me chuckle at tax scenarios! 😂

No secret; I didn't prepare last year. I requested 2018 thinking that the carryover loss happened then -- it didn't. Finally was able to procure 2017 from client, and lo and behold, that's where it occurred -- despite the fact that the client was then a RE professional and met both active and material participation standards. So, it appears the original carryover was invalid as @TaxGuyBill had speculated in his previous post... Joy!

The vacation rental is a "place at the lake," but has no owner use other than trips for repairs & maintenance. I, too, was initially skeptical, but he keeps copious logs of his repairs as well as all receipts; a welcome change from the norm! His average rental period is over 7 days, as they only do long-term rentals. Appears they deliberately structured it this way in order to keep it on their Schedule E. Why, I could not tell you.

Thank you for your thoughtful response and the chuckle! Enjoy the rest of your weekend!