PAL Carryforward for Recently Real Estate Professionals

[krisdestruction]

Hi,

Planning to transition into a Real Estate Professional (as defined by IRS) from non-material participation but have lots of Passive Activity Losses (PAL) from my previous years of rental properties on Schedule E. Wondering based on passive activity rules if I can start deducting the PAL carried forward against my income after I become a Real Estate Professional.

Edit: NOL->PAL for future searchability

[Critter-3]

Do you mean you have PASSIVE losses  reported on the form 8582 ?  Those are not the same as NOLs. 

[tagteam · Accepted solution]

@Critter-3 is correct; you almost certainly have years of passive activity losses (PALs) from your rental real estate activity(ies).

Qualifying as a real estate professional at this point will not somehow transform those passive losses incurred in prior years into nonpassive losses.

[krisdestruction]

You are correct, Form 8582

[krisdestruction]

A rental activity is a passive activity even if you materially participated in that activity, unless you materially participated as a real estate professional.

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https://www.irs.gov/pub/irs-pdf/p925.pdf

Additionally

The following aren’t passive activities.

5. Rental real estate activities in which you
materially participated as a real estate professional.

Am I to understand that if I become a Real Estate Professional, then I can treat my properties as non passive and offset against my regular income?

If you qualified as a real estate professional
for 2020, report income or losses from rental
real estate activities in which you materially participated as nonpassive income or losses

[tagteam]

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@krisdestruction wrote:
Am I to understand that if I become a Real Estate Professional, then I can treat my properties as non passive and offset against my regular income?

You need to materially participate as a real estate professional; the status, itself, is not sufficient.

See https://www.thetaxadviser.com/issues/2017/mar/navigating-real-estate-professional-rules.html

[krisdestruction]

Yes I understand material participation, 750 hours, 50% of business/trade time, etc. for the IRS definition. But still want to know if I can then start deducting my depreciation towards my "regular" (ie. w2, 1099) income

[tagteam]

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@krisdestruction wrote:

Yes I understand material participation, 750 hours, 50% of business/trade time, etc. for the IRS definition. But still want to know if I can then start deducting my depreciation towards my "regular" (ie. w2, 1099) income

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Yes, you can deduct any net loss on your rental(s) from your "regular" income provided you materially participate as a real estate professional.

The minimum hours and percentage requirements solely qualify you to meet the definition of real estate professional. Note that you still need to materially participate in your rental activities (as a real estate professional) before the net profit (income) will be treated as nonpassive.

[Critter-3 · Accepted solution]

Yes ... if you now qualify for the RE Pro election the prior year PAL will be released  ... but be very aware of what you are doing before trying this as this is a big IRS audit trigger and it may not be worth it ...

There is a good article here with this quote at the end ...  

https://www.thetaxadviser.com/issues/2017/mar/navigating-real-estate-professional-rules.html

"Taxpayers may wish to forgo the election, however, if they have suspended passive losses attributable to a rental activity that they intend to dispose of in the near future. Freeing up the suspended losses upon disposition will often yield a larger tax benefit to the taxpayer than currently using any rental losses." 

[krisdestruction]

Yes I don't plan to dispose of my rentals soon and I'm near the top tax bracket. Wanted to clarify it is PALs carried over from prior year"s" too right?

[Critter-3]

If you are near the top tax bracket then you can afford to employ a local tax pro to get educated on your situation and your options.  Relying on advice  from a nameless faceless internet forum is not the wisest choice so please spend a little to be confident in the choices you make.   

[krisdestruction]

This is more for the searchability for others in the community as I haven't found the information on TT before. Thought it'd be helpful to clarify and provide resources to others, but it seems like you're a bit sour for whatever reason. 

[tagteam]

@krisdestruction 

Have you read the article in the link that @Critter-3 posted earlier? The article is one of the best, and most comprehensive, available for free.

Regardless, you should be aware that in order to meet the material participation test, you might have to make an election to aggregate your rental activities and TurboTax simply does not support that election (hence, the suggestion to seek professional guidance). 

The passive activity loss rules are some of the most convoluted, confusing, somewhat incomprehensible, and even contradictory in the tax code and regulations; even tax professionals have difficulty with their application. An in-person consultation with an experienced tax professional is the best option for these situations.

[krisdestruction]

Yes I've read parts of it and planning to read the rest later this week.

Yes, my understanding on the property aggregation is that TurboTax will add the election in a printable format but you have to mail in the return. 

[tagteam]

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@krisdestruction wrote:

Yes, my understanding on the property aggregation is that TurboTax will add the election in a printable format but you have to mail in the return. 

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Correct, but TurboTax does not support the election in the sense that there is a form statement specified in Section 1.469-9(g)(3); you have to use a blank form and complete the statement yourself in Forms Mode.