Table Of Contents
In this episode, Brandon and Thomas clarify the potential downsides of making the -9 grouping election to treat all your rental activities as one for real estate professionals - and why it might not be as bad as you think.
This episode is sponsored by Landlord Studio the 2022 Tax & Legal Summit.
Full Transcript:
This podcast has been transcribed using AI, please excuse spelling, grammatical, and other errors.
Thomas Castelli 0:00
You're now listening to the real estate CPA podcast. Your source for all things real estate, accounting
Brandon Hall 0:05
and tax. Here we reveal our secrets that can save you 1000s in taxes, streamline your accounting process and help grow your business. Stay tuned to hear insightful interviews with industry experts, successful real estate investors and current clients on what strategies they use to grow their business, and how they steer clear of Uncle Sam.
Thomas Castelli 0:29
Hi, everyone, thanks for tuning into this episode of The Real Estate CPA podcast your host Brandon Hall and Thomas Castelli here today to discuss a an important distinction for real estate professionals who group all of their rentals together. So there is an issue where when you group all your rentals together and treat them all as one activity, and then you sell one of your rentals, you may not be able to use the losses or at least that's what a lot of CPAs think. And we're here to clarify that today and discuss what the real downsides of making the election really are or are there downsides at all. But before we dive right into that, if you're doing yourself landlord managing rental properties landlord studio is made for you. The software helps landlords simplify income and expense tracking. With their easy to use app, you can digitize receipts, record income and expenses in real time and generate reports and even manage leases and tenants plus landlord Studio makes late rental payments and bank visits a problem of the past with secure online rent collection get the rent paid directly to your bank account. And you can even automate rent reminder emails and late payment fees. Landlord studio is also the best way to stay tax compliant, they offer a range of financial reports including Schedule II and supplier expense reports designed for tax time, you can learn more about landlord studio and start your 14 day free trial at landlord studio.com/cpa. And use the coupon code real estate CPA at checkout to get 25% off your plan. Again, that's landlord studio.com/cpa and use the code real estate CPA to get 25% off your plan today.
Brandon Hall 2:03
Alright, so before we dive in, let me kind of frame the context here to give our listeners a better idea of what we're talking about. So when you qualify as a real estate professional, you know, that's the 750 hour test more time in real estate or real property trades or businesses than anywhere else. But you also have to materially participate in your rental portfolio. Because if I'm just a broker, or an agent or a builder, or a wholesaler or a flipper, I can hit real estate professional status doing one of those things because one of those activities are going to be a real property trader business under Section 469. But if I forget to also materially participate in my rental portfolio, then even though I'm a real estate professional, my rental portfolio is still passive. Okay, so I always have to come back and materially participate in my rental portfolio, I have to make sure that I'm materially participating my rental portfolio and material participation, there's seven tests, the test that we see most often are spending 500 hours on my rental portfolio or on my rental activity, spending 100 hours and more than anyone else, or substantially all the participation is my participation, meaning I'm really the only one doing the work. I'm self managing, I do all the repairs. So those are the three tests, you'll have to meet one of them. But those are the three that we see most often. The issue is that material participation is evaluated on an activity by activity basis. And each rental property is a separate activity. So if I have 10 rentals, then I have to spend if I'm going to go for that 500 hours Safe Harbor, I have to spend 500 hours on each rental separately, right. So 5000 total hours on 10 rentals. So in the Treasury regulations, one 469 dash nine G, there is a grouping election that allows you to group all of your rentals together as one, when you are a qualifying real estate professional, it's only in effect when you're qualifying real estate professional. So if I qualified real estate professional, and I have a rental portfolio, and I make this grouping election, then I get to treat all of my rental activities as one rental activity, meaning that across my entire portfolio, I can spend 500 hours to materially participate in my entire portfolio. And now all of my rental activities are considered non passive. And that's so critical to a lot of the strategies that we deploy with clients. Because if you do that, I mean think about that. Now I've got these rentals that I grouped together I materially participate in. Now I buy the next rental and I cost segregate it, I don't have to materially participate in it because I'm already materially participating in the group, right? So the next rental I could put a property manager on I could cost segregate I could get a million dollar multiplex and 250k of bonus depreciation, it's gonna yield 250k of losses or so or 200k of losses tax losses that I didn't get to claim against my other income. So really, really powerful strategy, especially if you're in acquisition mode. So you got to make sure that you understand that grouping election, we talked about it a lot. On our prior episodes, I think if you check out the reps series, our EP S series of the real estate CPA podcast, you just go go through iTunes and find reps. We talked about it there a little bit. But the important thing to understand is that when I group all my rentals together, it's so much easier, right? To materially participate in the group and make all of my rentals non passive. And then I can claim the tax losses against my other income really powerful strategy. The issue that a lot of tax preparers take up with this group anything is they get a little confused on how the loss rules apply to a group of rental activities. So if you make that nine election, a lot of preparers will tell you, you can no longer claim your losses when you sell a rental. So if I sold like rental a, out of a group of 10 rentals if I sell rental A and this nine G elections in place, so all my rentals are treated as one rental ASL at $100,000 gain. And if I have losses from my other rentals, suspended losses, a lot of tax preparers will tell you, you can't claim any of those losses. So you just have to report the $100,000 of gain. We're going to go into why they say that. And we're also going to go into why that is wrong on this podcast episode.
Thomas Castelli 6:26
Right. So if you look under Section 469 G, you'll find dispositions have an entire interest in the passive activity. And kind of in a nutshell, what that says that when you dispose of an entire activity. So again, what Brennan was saying before, if you own 10 rentals, right, so you own 10 rental properties, and you're not using the dash nine election. So you're not grouping them all together as one activity, they're still treated as their own individual activities, right. So you sell one of those properties, you're substantially disposing of the entire activity, because one property is the activity when you sell the property, you no longer have that activity. And then you can unlock the losses that are associated with the activity. And if those losses are in excess of the gain and the passive income associated with that activity in the year that you sell the activity, those losses are treated as non passive losses. So kind of just give you a little quick example, let's just say that you have property A, and you sell property a for $100,000. And out of the $100,000 $40,000 represents your gain. But over the years that you own property a you accumulated $50,000 In passive losses that were previously suspended. So you have $50,000 of suspended passive losses from property A, and you have a gain on the sale of property at $40,000. So the losses are going to first offset the gain on sale, so your gain on sale is going to be zero. So congratulations, you have mitigated your capital gains tax. But now that $10,000 of loss is now treated as non passive. And that can offset your W two or your other non passive income. So if you're not a real estate professional, that is how it works. Now, let's say that you qualify as a real estate professional, and you still own your 10 properties, you group them all together under this dash nine election, when you sell one out of your 10 properties, you are no longer substantially disposing of the entire activity, because one out of 10 is only 10%. That's not substantial. So what many tax preparers take this to mean is that you can't use any of your previous suspended passive losses because you are no longer disposing of the entire activity. However, if you look under Section 469, the statutory tax code, you will find that under Section 469 F that says the treatment of former passive activities, and it says that any unused deduction applicable to such activity shall be offset against the income from the activity for the taxable year. So basically, if you own these properties in the past, and you were not a real estate professional, they are passive by default. And then in a later year, you do qualify as a real estate professional, you pass the material participation tests, and they are treated as non passive activities. Well, it was a former passive activity, because in the past, it was passive. And you can use the losses from the former press activity against this activity because it was once a form of activity. So what I'm trying to say here is let me just illustrate with an example is that, let's go back to the example you sell the property for $100,000 at $100,000 $40,000 is a gain, and then you had the $50,000 of passive losses. Well, if they're not grouped together again, that $50,000 gets unlocked off screen then you have $10,000 of losses that can offset your W two or other passive income. Under this, when you make that grouping election, only $40,000 of your passive losses will be unlocked offset the game, not the entire amount. And that's really what the downside of the dash nine election is, is that if you do have these excess losses associated with the activity, that you can't use them to offset non passive income that year, but you can still use them to offset your game. And we're gonna take a quick break to hear a word from our sponsors. Hey everyone, we want to let you know that the real estate CPA will be hosting the third annual tax and legal summit for real estate investors coming up on Saturday February 26, and Sunday, February 27 2022. At this event, you'll learn about lucrative tax and asset protection strategies from the top tax and legal experts in the industry strategies include the real estate professional status, the short term rental loophole, passive losses, Cost Segregation studies, 1031 exchanges, self directed retirement accounts, entity structuring estate planning, and so much more. Don't miss this incredible event designed to save you 1000s in taxes and help protect the assets and wealth you work so hard to build, head on over to WW dot tax and legal summit.com to grab your free tickets today. Again, it's WW dot tax and legal summit.com to grab your free tickets today. Well, the tax and legal Summit is free to attend, we will have six exclusive sessions available to VIP ticket holders. And you can get 50% of VIP tickets by using the promo code podcast at checkout. We'll see you there. But for now we'll jump right back into today's episode.
Brandon Hall 11:08
Yeah, so section 469 G is the section that trips up a lot of prepares because it's the section that says disposition of entire interest in an activity. And the thought is well, if you're disposing of one out of 10, you're not disposing of the entire interest, therefore you cannot claim losses at all. But section 469 G makes it very clear that it's losses in excess of the gain that you cannot claim. Very important. And then like Tom was saying, section 469 F losses associated with a former passive activity, you're always able to claim those losses. But the issue with the nine election is you can't claim that extra $10,000 of losses, you can only claim the losses up to the gain on disposition. So the downside of a nine G election, the grouping election. The downside of this, like Tom was saying is that you can't claim the losses, but it's going to negatively impact real estate investors everywhere when we're in a down market. Now what does that mean? That means that our our asset prices are actually losing value, they're actually going down. And that means that the gain that we have built into these properties is getting smaller, which means that the losses that we have accumulated are not going to be utilized, right. So think about 2008 2009, where people literally lost their shirts, you know, if they had these nine elections in place, they would have to dispose of their entire portfolio in order to use the losses that their portfolio has built up over time. And if they don't dispose of their entire portfolio, they're liquidating these assets that are just starting to really sinking value, their gains are getting much smaller, or they're inverting, they don't even have gains anymore. They have actual real losses, meaning that they're selling the property for less than their adjusted basis. That's when you have real risk for this nine election here. So the important thing to understand is that making the non election, the grouping election to group all of your rentals together into one, for the purposes of material participation doesn't carry much risk, you're always going to be able to sell a property inside of that group. And you're going to be able to offset the gain with the losses that you have from that group doesn't have to even be you know, the one rent the property committee from the entire group. And if we have anybody out there saying, Well, no, I don't believe that or that doesn't make any sense. I really encourage you to go touch base with your CPA or your tax advisor, have them prepare a pro forma tax return for you. A pro forma just means a projection tax return or projected tax return, you can put scenarios into place, we all have software that we professional planning software that we can do this with. So you would go to your taxpayer and say, Hey, I would like to see what happens, I would like to see a sample tax return for me with all my same income information. But I want to see what this nine election does. So I want to group together my property. And then I want you to run through this scenario of me selling a rental at a gain of you know, whatever 50,000 75,000. What you will find when they prepare this pro forma for you is that you report the gain on sale report the sale of the rental and the associated gain on form four 797. That's where you report the sale of business assets. So form 4797 is where we're going to put this rental property that we're selling it again, it's going to detail the selling costs, the current adjusted basis, the depreciation, all that stuff. But at the end of the forum, it's going to have an aggregate gain amount. And guess where that gain goes, it flows to form 8582 Typically, section one a or line one a so it's going to flow to form 8582 in form 8582. I've said it before and I say in our courses that we run and if you haven't checked out our courses, you certainly should What's the link for that?
Thomas Castelli 14:53
Yeah, it's courses dot tax morning investors.com where you can just go to tax money investors.com And there's line says courses right on the navbar, and it'll show you all the courses we have available pay go, we're running
Brandon Hall 15:03
them once every two months or so to three months. So get in there. We talked about all this stuff. But it goes to form 8582. And form 8582 is the most important form. That's my belief. I know that there's probably other taxpayers out there that will disagree. I believe for real estate investors form 8582 is the most important form and your entire tax return because he aggregates all of your passive activities together, it shows you your suspended passive loss that you're carrying forward, you can make decisions from that information, I think it's more important than your Schedule II than your 1040. I think it's more important than anything, especially in the years that you switch CPAs, we've seen instances where the next CPA forgets to look at form 8582, and carry forward all the suspended passive losses. We've literally seen an instance with a client, where $300,000 of suspended passive losses simply disappeared in a year that they transition to a new CPA. So form 8582 aggregates all of your passive activities together. And when you sell a passive activity at a gain, that gain flows into form 8582. Well, since it's on form 8582, guess what you can use to offset the gain with you can use your passive losses from your other passive activities to offset the gain on form 8582. Now, that form just simplifies everything that we just said in this podcast. So it simplifies the Internal Revenue Code and the regulations. But that's what I always encourage people to do when they're working with tax preparers that don't quite get this because then your tax payers gonna see it on the forum, a lot of tax payers, they don't start with the code, they start with the software. And they their belief is if the software allows me to do it, then it can be done. Or if the software does not allow me to do it, then it cannot be done. And they're right, you know, probably 99% of the time, software is pretty good these days. But what they'll realize is everything's flowing into form 8582. In the gain, on the sale of this one rental in this group of rentals is still being allowed to be offset by the losses associated with this group of rentals. So what are they going to do next? Now they're going to go to the code, and they're going to try to figure it out. Now they're going to go to their tax forums online and ask questions and try to figure it out. But they're starting with the software. So that's what I always encourage people to do is just is just go to your tax preparer, if they're pushing back, ask them to prepare a pro forma tax return, they will be shocked at the results. Yeah.
Thomas Castelli 17:29
So I mean, there you have it. For everybody out there who's wondering if you do make that dash nine election, is it really that bad? You know, are you really going to have all of those suspended, as opposed to you have stuck? And the answer questions, no, when you do sell an activity, you could still use the losses to the extent of the gain. And I'm gonna say this, from experience doing this, I've not seen many instances where people really have had passive losses that are in excess, it's not very common of the gain, especially in this market. To Brandon's point earlier. You know, in a down market, that might be a different case. But you know, over recent years, at least, that has not being the case. And one
Brandon Hall 18:01
last thing before we close this out, one of our favorite tax people, Tony Nitti, wrote an article for Forbes, I believe it was Forbes, it was a while ago, but he was explaining this exact concept that we're explaining, and he does a really good job of it. So if anybody is listening to this, and you're like a technical tax person, I recommend that you go and try to find that Forbes article by Tony Nitti, they will explain everything that we just did in greater detail with more citations. So that'll be a really good place for you to go and learn more information.
Thomas Castelli 18:30
Yeah. And also, I'm going to be releasing an article on this in the not too distant future on our tax return investors platform. So if your basic or your plus subscriber, you'll have access to article and I'm going to include all the citations as well. So you'll have that as a resource. So go ahead and check that out if you haven't already.
Brandon Hall 18:45
Thanks for listening to today's show. If you enjoyed the show, please find us on iTunes and leave us a review. You can also email us at contact at the real estate CPA comm with any feedback or topic suggestions, we are always taking on new clients and with the new tax laws in play. You really don't want to navigate this alone. Let us help you save money on taxes with your accounting and CFO needs. To become a client navigate to our client page at the real estate CPA calm and fill out a webform with as much detail about your situation as possible. Thanks so much for listening. Have a great rest of your week.
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