The passive loss rules of the Internal Revenue Code limit the ability of taxpayers to use “passive” losses to offset “active” income. In general, a rental real estate activity is treated as per se passive under these rules. For real estate professionals, however, rental real estate activities may be treated as being active (i.e., can be used to offset non-passive income) if certain requirements are satisfied. A recent Tax Court decision illustrates the circumstances under which a real estate professional’s losses from rental real estate will be active or passive and how an election can sometimes make all the difference.

Background

In 1986, Congress enacted Internal Revenue Code section 469 in order to limit a taxpayer’s ability to use losses and credits from passive activities to offset active income. Congress was concerned with the growing participation of taxpayers in tax shelters, enterprises in which taxpayers would engage in certain activities to obtain deductions or credits which exceeded the taxpayers’ true economic costs from these activities and then would use these deductions or credits to offset salary or other active income. Under section 469, a taxpayer may net losses from passive activities against income from passive activities, but is precluded from using a net passive activity loss to offset active income. Section 469 applies to any individual, estate, trust, personal service corporation, or closely held C corporation (although closely held C corporations are subject to a modified set of rules).

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