[Federal Register Volume 60, Number 6 (Tuesday, January 10, 1995)]
[Proposed Rules]
[Pages 2557-2562]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-170]



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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[PS-80-93]
RIN 1545-AS38


Rules for Certain Rental Real Estate Activities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations providing rules 
for rental real estate activities of taxpayers engaged in certain real 
property trades or businesses. The proposed regulations reflect changes 
to the law made by the Omnibus Budget Reconciliation Act of 1993, and 
affect taxpayers subject to the limitations on passive activity losses 
and passive activity credits.

DATES: Written comments must be received by April 10, 1995. Outlines of 
oral comments to be presented at a public hearing scheduled for 
Thursday, May 11, 1995, at 10 a.m. must be received by April 20, 1995.

ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (PS-80-93), room 5228, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. In the alternative, submissions may be hand delivered between 
the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:T:R (PS-80-93), 
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW., 
Washington, DC.
    The public hearing will be held in the auditorium of the Internal 
Revenue Building, 1111 Constitution Avenue NW., Washington, DC 20224.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, William M. 
Kostak, (202) 622-3080; concerning submissions and the hearing, Carol 
Savage, (202) 622-8452 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in this notice of proposed 
rulemaking has been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act (44 U.S.C. 
3504(h)). Comments on the collection of information should be sent to 
the Office of Management and Budget, Attn: Desk Officer for the 
Department of the Treasury, Office of Information and Regulatory 
Affairs, Washington, DC 20503, with copies to the Internal Revenue 
Service, Attn: IRS Reports Clearance Officer, PC:FP, Washington, DC 
20224.
    The collection of information is in Sec. 1.469-9(g). This 
information is required by the IRS to administer the rules under 
section 469(c)(7). This information will be used to determine whether a 
taxpayer that qualifies for relief under section 469(c)(7) has made the 
election to treat all of the taxpayer's interests in rental real estate 
as a single rental real estate activity as provided in section 
469(c)(7)(A). The likely respondents are individuals or households, 
business or other for-profit institutions, and small businesses or 
organizations.
    Estimated total annual reporting burden for making or revoking the 
election: 3,015 hours.
    The estimated annual burden per respondent varies from 0.10 hours 
to 0.25 hours, depending on individual circumstances, with an estimated 
average of 0.15 hours.
    Estimated number of respondents: 20,000 electing/100 revoking.
    Estimated annual frequency of responses: on occasion.

Background

    This document proposes amendments to 26 CFR part 1 to provide rules 
relating to the treatment of rental real estate activities of certain 
taxpayers under the passive activity loss and credit limitations of 
section 469. Section 469 disallows losses from passive activities to 
the extent they exceed income from passive activities and similarly 
disallows credits from passive activities to the extent they exceed tax 
liability allocable to passive activities. In general, passive 
activities are activities in which the taxpayer does not 
[[Page 2558]] materially participate. In addition, until the enactment 
of the Omnibus Budget Reconciliation Act of 1993 (OBRA 1993), all 
rental activities (including those in which a taxpayer materially 
participated) were passive.
    OBRA 1993 added a new section 469(c)(7), which provides that rental 
real estate activities of qualifying taxpayers are not subject to the 
rule that treats all rental activities as passive. Thus, a rental real 
estate activity of a qualifying taxpayer is not passive if the taxpayer 
materially participates in the activity. Second, the new rules provide 
that each of a qualifying taxpayer's interests in rental real estate is 
treated as a separate activity unless the taxpayer elects to treat all 
interests in rental real estate as a single activity.
    To qualify for this treatment under section 469(c)(7) for a taxable 
year, a taxpayer must perform, during that year, over 750 hours of 
personal services, and over half of the taxpayer's total personal 
services, in real property trades or businesses in which the taxpayer 
materially participates. A closely held C corporation is treated as 
satisfying these tests if more than 50 percent of its gross receipts 
for the taxable year are derived from real property trades or 
businesses in which it materially participates. For purposes of the 
qualification tests, a real property trade or business is defined as 
any real property development, redevelopment, construction, 
reconstruction, acquisition, conversion, rental, operation, management, 
leasing, or brokerage trade or business.

Explanation of Provisions

1. Treatment of Rental Real Estate Activities of Qualifying Taxpayers

    The proposed regulations provide that a rental real estate activity 
of a qualifying taxpayer will remain passive for a taxable year unless 
the taxpayer materially participates in the activity. This rule applies 
to all rental real estate activities of a qualifying taxpayer, 
including those giving rise to expenses described in section 212 of the 
Code.

2. Determination of Rental Real Estate Activities

    The proposed regulations provide that the election to treat all 
interests in rental real estate as a single activity is binding for the 
taxable year in which it is made and for all future years in which the 
taxpayer is a qualifying taxpayer unless there is a material change in 
the taxpayer's facts and circumstances and the election is revoked. In 
addition, the regulations clarify that an electing taxpayer's limited 
partnership interests in rental real estate are combined with the 
taxpayer's other interests in rental real estate into a single rental 
real estate activity. The regulations also clarify that interests in 
rental real estate cannot be combined with other trades or businesses 
of the taxpayer into a single activity. For this purpose, however, any 
rental real estate that a taxpayer groups with a trade or business 
activity under Sec. 1.469-4(d)(1)(i) (A) or (C) is not treated as an 
interest in rental real estate.

3. Treatment of Limited Partners

    Section 469(c)(7) provides that the new rules for rental real 
estate activities are not to be construed as affecting the 
determination of whether a qualifying taxpayer materially participates 
with respect to any interest in a limited partnership as a limited 
partner. Thus, material participation with respect to a limited 
partnership interest is determined in accordance with section 
469(h)(2), which provides that limited partners are treated as material 
participants only to the extent provided in regulations. The existing 
temporary regulations provide that material participation can generally 
be established by satisfying one of seven tests, but only three of 
these tests can be used to establish material participation with 
respect to limited partnership items. Accordingly, the proposed 
regulations provide that a qualifying taxpayer generally must establish 
material participation in a rental real estate activity held, in whole 
or part, through limited partnership interests under one of the three 
tests available to limited partners under the temporary regulations. 
This rule does not apply if the taxpayer elects to treat all interests 
in rental real estate as a single activity and less than 10 percent of 
the taxpayer's gross rental income from the activity is attributable to 
limited partnership interests. In that case, the taxpayer may use any 
of the seven tests under the temporary regulations to establish 
material participation in the activity.

4. Qualification Tests

    As noted above, a taxpayer qualifies for the treatment prescribed 
in section 469(c)(7) by performing personal services in real property 
trades or businesses in which the taxpayer materially participates. The 
proposed regulations provide that, for purposes of the qualification 
tests, the determination of a taxpayer's real property trades or 
businesses is based on all of the relevant facts and circumstances. A 
taxpayer may use any reasonable method of applying the facts and 
circumstances, but the determination must generally be applied 
consistently from year to year. The proposed regulations also provide 
that material participation in a real property trade or business is 
determined under the generally applicable rules of the existing 
temporary regulations.

5. Coordination With Former Passive Activity Rules

    The proposed regulations clarify the treatment of suspended losses 
and credits allocable to a nonpassive rental real estate activity. They 
provide that the former passive activity rules of section 469(f) apply. 
Thus, the suspended loss or credit may be used to offset income from, 
or tax liability allocable to, the rental real estate activity, and any 
remaining loss or credit is treated as a loss or credit from a passive 
activity.

6. Coordination With $25,000 Offset for Rental Real Estate Activities

    The proposed regulations clarify that a suspended loss or credit 
attributable to a nonpassive rental real estate activity may qualify 
under section 469(i) as a loss or credit from a rental real estate 
activity in which the taxpayer actively participates. Under section 
469(i), such a loss or credit may be used to offset nonpassive income 
or tax liability attributable to nonpassive income, subject to a 
$25,000 limitation and an adjusted gross income phaseout. The proposed 
regulations also clarify that the $25,000 limitation is not reduced by 
losses or credits that are allowable under section 469(c)(7).

7. Regrouping Under the Activity Rules

    The regulations defining an activity for purposes of section 469 
(Sec. 1.469-4) include a consistency requirement. Once a taxpayer has 
grouped activities, they may not be regrouped unless the grouping is 
clearly inappropriate or there has been a material change in the facts 
and circumstances. The proposed regulations provide an exception to the 
consistency requirement for the first taxable year in which section 
469(c)(7) applies. In that year, a taxpayer is permitted to regroup its 
activities to the extent necessary or appropriate to avail itself of 
the new rules.
    The proposed regulations also provide that a taxpayer who adopted 
(or retained) a grouping of activities under Project PS-1-89 (the 
proposed definition of activity regulations) published in 1992 may 
regroup activities in the first taxable year in which the taxpayer 
determines tax liability under the rules of the final definition of 
activity regulations rather than under the proposed definition of 
activity regulations. The regulations also clarify that, in the first 
taxable year in [[Page 2559]] which a taxpayer applies the rules of 
either the proposed definition of activity regulations or the final 
definition of activity regulations in determining tax liability, the 
taxpayer must regroup its activities if its previous grouping is 
inconsistent with the applicable rules. Although the rules permitting 
or requiring a taxpayer to regroup activities refer to the taxpayer's 
determination of tax liability under section 469, they will be applied 
to partnerships and S corporations conducting activities subject to 
section 469.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in EO 12866. Therefore, 
a regulatory assessment is not required. It also has been determined 
that section 553(b) of the Administrative Procedure Act (5 U.S.C. 
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do 
not apply to these regulations, and, therefore, a Regulatory 
Flexibility Analysis is not required. Pursuant to section 7805(f) of 
the Internal Revenue Code, this notice of proposed rulemaking will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) that are submitted timely to the IRS. All 
comments will be available for public inspection and copying.
    A public hearing has been scheduled for Thursday, May 11, 1995, at 
10:00 a.m. in the auditorium of the Internal Revenue Building. Because 
of access restrictions, visitors will not be admitted beyond the 
Internal Revenue Building lobby more than 15 minutes before the hearing 
starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons that wish to present oral comments at the hearing must 
submit written comments and outlines of the topics to be discussed and 
the time to be devoted to each topic (signed original and eight (8) 
copies) by April 20, 1995.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

    The principal author of these regulations is William M. Kostak, 
Office of Assistant Chief Counsel (Passthroughs and Special 
Industries), IRS. However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART I--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805. * * *

    Section 1.469-9 also issued under 26 U.S.C. 469(c)(6), (h)(2), and 
(l)(1).

    Par. 2. Section 1.469-0 is amended by:
    1. Revising the entry for Sec. 1.469-4(h).
    2. Revising the heading for Sec. 1.469-9 and adding entries for 
paragraphs (a) through (j) of Sec. 1.469-9.
    3. Revising the entry for Sec. 1.469-11(b)(2) and removing the 
entries for Sec. 1.469-11(b)(2) (i) and (ii).
    4. Revising the entry for Sec. 1.469-11(b)(3).
    5. Adding an entry for Sec. 1.469-11(b)(4).
    6. The revisions and additions read as follows:


Sec. 1.469-0  Table of contents.

* * * * *

Sec. 1.469-4  Definition of Activity.

* * * * *
    (h) Rules for grouping rental real estate activities for 
taxpayers qualifying under section 469(c)(7).
* * * * *

Sec. 1.469-9  Rules for certain rental real estate activities.

(a) Scope and purpose.
(b) Definitions.
    (1) Trade or business.
    (2) Real property trade or business.
    (3) Rental real estate.
    (4) Personal services.
    (5) Material participation.
    (6) Qualifying taxpayer.
(c) Requirements for qualifying taxpayers.
    (1) In general.
    (2) Requirement of material participation in the real property 
trades or businesses.
    (3) Treatment of spouses.
    (4) Employees in real property trades or businesses.
(d) General rule for determining real property trades or businesses.
    (1) Facts and circumstances.
    (2) Consistency requirement.
(e) Treatment of rental real estate activities of a qualifying 
taxpayer.
    (1) In general.
    (2) Treatment as a former passive activity.
    (3) Grouping rental real estate activities with other 
activities.
(f) Limited partnership interests in rental real estate activities.
    (1) In general.
    (2) De minimis exception.
(g) Election to treat all interests in rental real estate as a 
single rental real estate activity.
    (1) In general.
    (2) Certain changes not material.
    (3) Filing a statement to make or revoke the election.
(h) Interests in rental real estate held by certain passthrough 
entities.
    (1) General rule.
    (2) Special rule if a qualifying taxpayer holds a fifty-percent 
or greater interest in a passthrough entity.
(i) [Reserved].
(j) $25,000 offset for rental real estate activities of qualifying 
taxpayers.
    (1) In general.
    (2) Example.
* * * * *

Sec. 1.469-11  Effective date and transition rules.

* * * * *
(b) * * *
    (2) Additional transition rule for 1992 amendments.
    (3) Fresh starts under consistency rules.
    (i) Regrouping when tax liability is first determined under 
Project PS-1-89.
    (ii) Regrouping when tax liability is first determined under 
Sec. 1.469-4.
    (iii) Regrouping when taxpayer is first subject to section 
469(c)(7).
    (4) Certain investment credit property.
* * * * *
    Par. 3. Section 1.469-4 is amended by revising paragraph (e)(1) and 
the heading of paragraph (h) and by adding the text of paragraph (h) to 
read as follows:


Sec. 1.469-4  Definition of Activity.

* * * * *
    (e) * * *
    (1) Original groupings. Except as provided in paragraph (e)(2) of 
this section and Sec. 1.469-11, once a taxpayer has grouped activities 
under this section, the taxpayer may not regroup those activities in 
subsequent taxable years. Taxpayers must comply with disclosure 
requirements that the Commissioner may prescribe with respect to both 
their original groupings and the addition and disposition of specific 
activities within those chosen groupings in subsequent taxable years.
* * * * *
    (h) Rules for grouping rental real estate activities for taxpayers 
qualifying under section 469(c)(7). See Sec. 1.469-9 [[Page 2560]] for 
rules for certain rental real estate activities.
    Par. 4. The heading of section 1.469-9 is revised, and the text of 
this section is added to read as follows:


Sec. 1.469-9  Rules for certain rental real estate activities.

    (a) Scope and purpose. This section provides guidance to taxpayers 
engaged in certain real property trades or businesses on applying 
section 469(c)(7) to their rental real estate activities.
    (b) Definitions. The following definitions apply for purposes of 
this section:
    (1) Trade or business. A Trade or business is any trade or business 
determined by treating the types of activities in Sec. 1.469-4(b)(1) as 
if they involved the conduct of a trade or business, and any interest 
in rental real estate, including any interest in rental real estate 
that gives rise to deductions under section 212.
    (2) Real property trade or business. Real property trade or 
business is defined in section 469(c)(7)(C).
    (3) Rental real estate. Rental real estate is any real property 
used by customers or held for use by customers in a rental activity 
within the meaning of Sec. 1.469-1T(e)(3). However, any rental real 
estate that the taxpayer grouped with a trade or business activity 
under Sec. 1.469-4(d)(1)(i) (A) or (C) is not an interest in rental 
real estate for purposes of this section.
    (4) Personal services. Personal services means any work performed 
by an individual in connection with a trade or business. However, 
personal services do not include any work performed by an individual in 
the individual's capacity as an investor as described in Sec. 1.469-
5T(f)(2)(ii).
    (5) Material participation. Material participation has the same 
meaning as under Sec. 1.469-5T. Paragraph (f) of this section contains 
rules applicable to limited partnership interests in rental real estate 
that a qualifying taxpayer elects to aggregate with other interests in 
rental real estate of that taxpayer.
    (6) Qualifying taxpayer. A qualifying taxpayer is a taxpayer that 
owns at least one interest in rental real estate and meets the 
requirements of paragraph (c) of this section.
    (c) Requirements for qualifying taxpayers--(1) In general. A 
qualifying taxpayer must meet the requirements of section 469(c)(7)(B). 
A closely held C corporation meets these requirements by satisfying the 
requirements of section 469(c)(7)(D)(i). For purposes of section 
469(c)(7)(D)(i), gross receipts do not include items of portfolio 
income within the meaning of Sec. 1.469-2T(c)(3).
    (2) Requirement of material participation in the real property 
trades or businesses. A taxpayer must materially participate in a real 
property trade or business in order for the personal services provided 
by the taxpayer in that real property trade or business to count 
towards meeting the requirements of paragraph (c)(1) of this section.
    (3) Treatment of spouses. Spouses filing a joint return are 
qualifying taxpayers only if one spouse separately satisfies both 
requirements of section 469(c)(7)(B). In determining the real property 
trades or businesses in which a married taxpayer materially 
participates (but not for any other purpose under this paragraph (c)), 
work performed by the taxpayer's spouse in a trade or business is 
treated as work performed by the taxpayer under Sec. 1.469-5T(f)(3), 
regardless of whether the spouses file a joint return for the year.
    (4) Employees in real property trades or businesses. For purposes 
of paragraph (c)(1) of this section, personal services performed during 
a taxable year as an employee generally will be treated as performed in 
a trade or business but will not be treated as performed in a real 
property trade or business, unless the taxpayer is a five-percent owner 
(within the meaning of section 416(i)(1)(B)) in the employer at all 
times during the taxable year.
    (d) General rule for determining real property trades or 
businesses--(1) Facts and circumstances. The determination of a 
taxpayer's real property trades or businesses for purposes of paragraph 
(c) of this section is based on all of the relevant facts and 
circumstances. A taxpayer may use any reasonable method of applying the 
facts and circumstances in determining the real property trades or 
businesses in which the taxpayer provides personal services. Depending 
on the facts and circumstances, a real property trade or business 
consists either of one or more than one trade or business specifically 
described in section 469(c)(7)(C).
    (2) Consistency requirement. Once a taxpayer determines the real 
property trades or businesses in which personal services are provided 
for purposes of paragraph (c) of this section, the taxpayer may not 
redetermine those real property trades or businesses in subsequent 
taxable years unless the original determination was clearly 
inappropriate or there has been a material change in the facts and 
circumstances that makes the original determination clearly 
inappropriate.
    (e) Treatment of rental real estate activities of a qualifying 
taxpayer--(1) In general. Section 469(c)(2) does not apply to any 
rental real estate activity of a taxpayer for a taxable year in which 
the taxpayer is a qualifying taxpayer under paragraph (c) of this 
section. Instead, a rental real estate activity of a qualifying 
taxpayer is a passive activity under section 469 for the taxable year 
unless the taxpayer materially participates in the activity. Each 
interest in rental real estate of a qualifying taxpayer will be treated 
as a separate rental real estate activity, unless the taxpayer makes an 
election under paragraph (g) of this section to treat all interests in 
rental real estate as a single rental real estate activity.
    (2) Treatment as a former passive activity. For any taxable year in 
which a qualifying taxpayer materially participates in a rental real 
estate activity, that rental real estate activity will be treated as a 
former passive activity under section 469(f) if disallowed deductions 
or credits are allocated to the activity under Sec. 1.469-1(f)(4).
    (3) Grouping rental real estate activities with other activities. 
For purposes of this section, a qualifying taxpayer may not group a 
rental real estate activity with any other activity of the taxpayer. 
For example, if a qualifying taxpayer develops real property, 
constructs buildings, and owns an interest in rental real estate, the 
taxpayer's interest in rental real estate may not be grouped with the 
taxpayer's development activity or construction activity. Thus, only 
the participation of the taxpayer with respect to the rental real 
estate may be used to determine if the taxpayer materially participates 
in the rental real estate activity under Sec. 1.469-5T.
    (f) Limited partnership interests in rental real estate 
activities--(1) In general. If a taxpayer elects under paragraph (g) of 
this section to treat all interests in rental real estate as a single 
rental real estate activity, and at least one interest in rental real 
estate is held by the taxpayer as a limited partnership interest 
(within the meaning of Sec. 1.469-5T(e)(3)), the combined rental real 
estate activity will be treated as a limited partnership interest of 
the taxpayer for purposes of determining material participation. 
Accordingly, the taxpayer will not be treated under this section as 
materially participating in the combined rental real estate activity 
unless the taxpayer materially participates in the activity under the 
tests listed in Sec. 1.469-5T(e)(2) (dealing with the tests for 
determining the material participation of a limited partner).
    (2) De minimis exception. If a qualifying taxpayer elects under 
[[Page 2561]] paragraph (g) of this section to treat all interests in 
rental real estate as a single rental real estate activity, and the 
taxpayer's share of gross rental income from all of the taxpayer's 
limited partnership interests in rental real estate is less than ten 
percent of the taxpayer's share of gross rental income from all of the 
taxpayer's interests in rental real estate for the taxable year, 
paragraph (f)(1) of this section does not apply. Thus the taxpayer may 
determine material participation under the seven tests listed in 
Sec. 1.469-5T(a).
    (g) Election to treat all interests in rental real estate as a 
single rental real estate activity--(1) In general. A qualifying 
taxpayer may make an election to treat all of the taxpayer's interests 
in rental real estate as a single rental real estate activity. This 
election is binding for the taxable year in which it is made and for 
all future years in which the taxpayer is also a qualifying taxpayer. 
However, if there is a material change in a taxpayer's facts and 
circumstances, the taxpayer may revoke the election using the procedure 
described in paragraph (g)(3) of this section.
    (2) Certain changes not material. The fact that an election is less 
advantageous to the taxpayer in a particular taxable year is not, of 
itself, a material change in the taxpayer's facts and circumstances. 
Similarly, a break in the taxpayer's status as a qualifying taxpayer is 
not, of itself, a material change in the taxpayer's facts and 
circumstances.
    (3) Filing a statement to make or revoke the election. A qualifying 
taxpayer makes the election to treat all interests in rental real 
estate as a single rental real estate activity by filing a statement 
with the taxpayer's original income tax return for the taxable year. 
This statement must contain a declaration that the taxpayer is a 
qualifying taxpayer for the taxable year and is making the election 
pursuant to section 469(c)(7)(A). The taxpayer may make this election 
for any taxable year in which section 469(c)(7) is applicable. A 
taxpayer may revoke the election only in the taxable year in which a 
material change in the taxpayer's facts and circumstances occurs. To 
revoke the election, the taxpayer must file a statement with the 
taxpayer's original income tax return for that year. This statement 
must contain a declaration that the taxpayer is revoking the election 
under section 469(c)(7)(A) and an explanation of the nature of the 
material change.
    (h) Interests in rental real estate held by certain passthrough 
entities--(1) General rule. Except as provided in paragraph (h)(2) of 
this section, a qualifying taxpayer's interest in rental real estate 
held by a partnership or an S corporation (passthrough entity) is 
treated as a single interest in rental real estate if the passthrough 
entity grouped its rental real estate as one rental activity under 
Sec. 1.469-4(d)(5). If the passthrough entity groups its rental real 
estate into separate rental activities under Sec. 1.469-4(d)(5), each 
rental real estate activity of a passthrough entity will be treated as 
a separate interest in rental real estate of a qualifying taxpayer. 
However, a taxpayer may elect under paragraph (g) of this section to 
treat all interests in rental real estate, including the rental real 
estate interests held through passthrough entities, as a single rental 
real estate activity.
    (2) Special rule if a qualifying taxpayer holds a fifty-percent or 
greater interest in a passthrough entity. If a qualifying taxpayer 
holds a fifty-percent or greater interest in the capital, income, gain, 
loss, deduction, or credit of a passthrough entity at any time during 
the taxable year, each interest in rental real estate held by the 
passthrough entity will be treated as a separate interest in rental 
real estate of the qualifying taxpayer, regardless of the passthrough 
entity's grouping of activities under Sec. 1.469-4(d)(5). However, the 
taxpayer may elect under paragraph (g) of this section to treat all 
interests in rental real estate, including the rental real estate 
interests held through passthrough entities, as a single rental real 
estate activity.
    (i) [Reserved].
    (j) $25,000 offset for rental real estate activities of qualifying 
taxpayers--(1) In general. A qualifying taxpayer's passive losses and 
credits from rental real estate activities (including suspended passive 
activity losses and credits from rental real estate activities in which 
the taxpayer materially participates) are allowed to the extent 
permitted under section 469(i).
    (2) Example. The following example illustrates the application of 
this paragraph (j).

    Example. (i) Taxpayer A owns building X and building Y, both 
interests in rental real estate. In 1995, A is a qualifying taxpayer 
within the meaning of paragraph (c) of this section. A does not 
elect to treat X and Y as one activity under section 469(c)(7)(A) 
and paragraph (g) of this section. As a result, X and Y are treated 
as separate activities pursuant to section 469(c)(7)(A)(ii). A 
materially participates in X which has $100,000 of passive losses 
disallowed from prior years and produces $20,000 of losses in 1995. 
A does not materially participate in Y which produces $40,000 of 
income in 1995. A also has $50,000 of income from other nonpassive 
sources in 1995. A otherwise meets the requirements of section 
469(i).
    (ii) Because X is not a passive activity in 1995, the $20,000 of 
losses produced by X in 1995 are nonpassive losses that may be used 
by A to offset part of the $50,000 of nonpassive income. 
Accordingly, A is left with $30,000 ($50,000-$20,000) of nonpassive 
income. In addition, A may use the prior year disallowed passive 
losses of X to offset any income from X and passive income from 
other sources. Therefore, A may offset the $40,000 of passive income 
from Y with $40,000 of passive losses from X.
    (iii) Because A has $60,000 ($100,000-$40,000) of passive losses 
remaining from X and meets all of the requirements of section 
469(i), A may offset up to $25,000 of nonpassive income with passive 
losses from X pursuant to section 469(i). As a result, A has $5,000 
($30,000-$25,000) of nonpassive income remaining and disallowed 
passive losses from X of $35,000 ($60,000-$25,000) in 1995.

    Par. 5. Section 1.469-11 is amended as follows:
    1. Paragraph (a)(2) is amended by removing ``; and'' and adding 
``;'' in its place.
    2. Paragraph (a)(3) is redesignated as paragraph (a)(4) and a new 
paragraph (a)(3) is added.
    3. Paragraph (b)(2)(ii) is removed, paragraph (b)(2)(i) is 
redesignated as paragraph (b)(2), and the heading for paragraph (b)(2) 
is revised.
    5. Paragraph (b)(3) is redesignated as paragraph (b)(4).
    6. A new paragraph (b)(3) is added.
    7. The added and revised provisions read as follows:


Sec. 1.469-11  Effective date and transition rules.

    (a) * * *
    (3) The rules contained in Sec. 1.469-9 apply for taxable years 
beginning on or after January 1, 1995, and to elections made under 
Sec. 1.469-9(g) with returns filed on or after January 1, 1995; and * * 
*
* * * * *
    (b) * * * (2) Additional transition rule for 1992 amendments. * * *
    (3) Fresh starts under consistency rules--(i) Regrouping when tax 
liability is first determined under Project PS-1-89. For the first 
taxable year in which a taxpayer determines its tax liability under 
Project PS-1-89, the taxpayer may regroup its activities without regard 
to the manner in which the activities were grouped in the preceding 
taxable year and must regroup its activities if the grouping in the 
preceding taxable year is inconsistent with the rules of Project PS-1-
89.
    (ii) Regrouping when tax liability is first determined under 
Sec. 1.469-4. For the first taxable year in which a 
[[Page 2562]] taxpayer determines its tax liability under Sec. 1.469-4, 
rather than under the rules of Project PS-1-89, the taxpayer may 
regroup its activities without regard to the manner in which the 
activities were grouped in the preceding taxable year and must regroup 
its activities if the grouping in the preceding taxable year is 
inconsistent with the rules of Sec. 1.469-4.
    (iii) Regrouping when taxpayer is first subject to section 
469(c)(7). For the first taxable year beginning after December 31, 
1993, a taxpayer may regroup its activities to the extent necessary or 
appropriate to avail itself of the provisions of section 469(c)(7) and 
without regard to the manner in which the activities were grouped in 
the preceding taxable year.
* * * * *
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 95-170 Filed 1-9-95; 8:45 am]
BILLING CODE 4830-01-P