How to Make the 469(c)(7) Election for Real Estate
Understand how the 469(c)(7) election allows qualifying real estate professionals to group rental activities and deduct previously passive losses.
Taxpayers with rental real estate often face a hurdle due to the passive activity loss (PAL) rules. These rules prevent individuals from deducting losses from rental activities against other forms of income, such as wages or business profits, causing unusable losses to be carried forward. For individuals heavily involved in real estate, a specific provision offers a path to overcome this limitation.
The election under Internal Revenue Code (IRC) Section 469(c)(7) allows qualifying taxpayers to treat their rental real estate activities as non-passive. This reclassification permits the deduction of rental losses against all other sources of income, potentially leading to tax savings. Making this election transforms how rental activities are viewed for tax purposes, but it is only available to those who meet the criteria for a “real estate professional.”
Qualifying as a Real Estate Professional
To be considered a real estate professional, a taxpayer must satisfy two quantitative tests each year. Failing to meet both conditions in a given year means the taxpayer does not qualify, and any rental losses will remain subject to the standard passive activity limitations.
The first requirement is the “more than one-half” test. This test mandates that more than 50% of the total personal services a taxpayer performs during the year must be in real property trades or businesses where they materially participate. This ensures that real estate is their primary professional focus.
The second requirement is the “750-hour” test. A taxpayer must perform more than 750 hours of service during the tax year in real property trades or businesses where they materially participate. The IRS defines “real property trades or businesses” to include activities such as:
- Acquisition
- Brokerage
- Construction
- Conversion
- Development
- Leasing
- Management
- Operation
- Rental
Meeting these tests requires record-keeping. Taxpayers must maintain a log or other documentation that substantiates the hours and nature of their activities. Material participation is central to both tests and means being involved in the operations of the activity on a regular, continuous, and substantial basis.
Information Required for the Election Statement
A qualifying taxpayer must draft their own election statement, as the IRS does not provide a standard form for this purpose. This statement is a formal declaration that becomes a permanent part of the tax record for the year of the election.
The statement must begin with a clear declaration that the taxpayer is making the election. It should explicitly state the taxpayer’s name, Social Security Number, and the tax year for which the election is effective. For example, the statement might read, “I hereby elect to treat all of my interests in rental real estate as a single rental real estate activity for the tax year for which this return is filed.”
The document must also include a representation that the taxpayer meets the qualifications of a real estate professional. While detailed logs are not attached to the election, the statement should affirm that the taxpayer has satisfied the requirements for the year.
The core of the election is the decision to treat all interests in rental real estate as a single, aggregated activity, and the statement must clearly communicate this choice. By grouping all rental properties into one activity, it becomes easier to meet the material participation requirements for the rental activity as a whole in subsequent years.
Making the Election
The self-prepared election statement must be attached to the taxpayer’s original income tax return for the first year the election is to take effect. It must be filed with a Form 1040 or 1040-SR by the standard tax deadline or by the extended deadline if a valid extension is filed.
The election cannot be made on an amended return. A failure to include the statement with the original, timely filed return means the opportunity to make the election for that tax year is lost. However, a simplified procedure may be available to obtain late relief for taxpayers who fail to make a timely election.
Some tax software programs may allow for an electronic statement to be attached to an e-filed return. In other cases, the taxpayer may need to print and mail the return with the physical statement attached. The taxpayer should confirm the proper procedure to ensure the statement is successfully submitted with their return.
Post-Election Reporting and Considerations
The election is binding for the tax year it is made and for all future years. It cannot be easily revoked; a taxpayer must experience a material change in their facts and circumstances and receive consent from the IRS to do so, which is uncommon.
To deduct rental losses in any given year after the election is made, the taxpayer must still meet one of the material participation tests for their now-aggregated rental real estate activity. If they fail to meet a material participation test in a subsequent year, the losses for that year will revert to being passive.
The election also changes how rental activities are reported on the tax return. The aggregated rental real estate activity is reported as a single line item on Schedule E, Supplemental Income and Loss. This simplifies reporting, as the taxpayer no longer needs to analyze each property for passive activity loss limitations. The net income or loss from the single aggregated activity is then classified as non-passive, assuming the annual material participation test is met.