Chris asks the following excellent question about the consequences of qualifying for real estate professional status:
If I elect aggregation for RE professional status for 2 rentals, what are the implications when I sell? One possible scenario in this current market would be that I incur a loss on one property (even with recapturing depreciation!) and a gain on the other, presuming I sell both in the same tax year.
A: As with most tax questions, the answer is "it depends." It depends on whether you have always qualified as a real estate professional. If so, then you simply have gain or loss in the year of sale and that gain or loss is treated as a Section 1231 gain or loss. See your tax coach for more on the consequences of Section 1231 gain or loss (generally positive).
If you have not always been a real estate professional, you may have unused passive losses relating to these properties. If you sell the properties in a fully taxable disposition (e.g., there is no gift or 1031 exchange involved), you will free up these unused passive losses to be available for use against other income (including any gain from the sale).
If you sell one, but not the other, you will not free up any passive losses. This is because you have not disposed of the entire property (which, because of your aggregation election now includes both properties). You will not free up the losses until you dispose of the other property. The result is that you could end up with these passive losses trapped and unused for years and years.
For this reason, I strongly recommend you consult with your tax coach to determine the best tax strategy even before you make the aggregation election for the first time.
For more information on how to be a real estate professional for tax purposes or the consequences of doing so, see our new ProVision education product, How to Uncover the Hidden Cash Flow from your Real Estate at http://www.provisionwealth.com/products.
Warmest regards,
Tom