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Reconsidering the election to segregate rental real estate undertakings.

Many tax practitioners have informed their clients of the advantages of electing to segregate rental real estate undertakings. By making this election, losses that may not be deductible because of the passive loss rules can be used against ordinary or investment income when the separate undertaking is disposed of. However, there are certain situations in which making this election could cause serious problems.

One such situation occurs when the taxpayer is renting land or other nondepreciable property. If the taxpayer has other rental real estate undertakings, it is important to consider Temp. Regs. Sec. 1.469-2T(f)(3).

Temp. Regs. Sec. 1.469-2T(f)(3) describes situations in which rental income will be recharacterized as nonpassive if less than 30% of the unadjusted basis of the property used in rental activity is depreciable.

Example 1: Taxpayer T leases land costing $300,000 which has an improvement that costs $100,000. The sale of this property at a gain will generate nonpassive income, since only 25% of the unadjusted basis of the rental property ($100,000 of $400,000) is depreciable.

Example 2, on the left, provides further insight into this dilemma.

The passive loss rules necessitate rethinking whether segregating activities is always desirable. Once the aggregation election is made, it may not be possible to disaggregate (Temp. Regs. Sec. 1.469-4T(k)(3)). Therefore, it is essential that future dispositions be considered when intially making Temp. Regs. Sec. 1.469-4T(k) aggregation and segregation elections.

From Steven I. Touger, CPA, Stamford, Conn.
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Author:Touger, Steven I.
Publication:The Tax Adviser
Date:Feb 1, 1992
Words:252
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