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Chief Counsel Advice 201504010

In Chief Counsel Advice (CCA), IRS has concluded that a real estate agent who brings together buyers and sellers of real property can be a so-called “real estate professional” who is engaged in a real property brokerage trade or business as described in Code Sec. 469(c)(7)(C) of the passive activity loss (PAL) rules. However, a mortgage broker who is a broker of financial instruments isn’t engaged in a real property brokerage trade or business.

Background. Under the PAL rules, losses from passive activities may only be used to offset passive activity income. ( Code Sec. 469(a) ) Thus, such losses can’t be used to offset income from, for example, compensation, interest or dividends. ( Code Sec. 469(e) )

Under Code Sec. 469(c)(1) , the PAL disallowance rules apply to any trade or business in which the taxpayer does not materially participate. A taxpayer is treated as materially participating in an activity if he meets at least one of the seven tests in Reg. § 1.469-5T . Under one of those tests, an individual will be treated as materially participating in an activity for a tax year if the individual participates in the activity for more than 500 hours during such year. ( Reg. § 1.469-5T(a)(1) )

In general, any rental activity is per se a passive activity regardless of the taxpayer’s participation in the activity. ( Code Sec. 469(c)(2) ) However, there are exceptions to the general per se rule. Where an exception applies, a rental real estate activity is not a passive activity for the tax year if the taxpayer materially participates in the activity.

Under Code Sec. 469(c)(7) , the Code Sec. 469(c)(2) per se rule for rental activities doesn’t apply to a qualifying real estate professional. A taxpayer qualifies as such for a particular tax year if: (1) more than half of the personal services that he performs during that year are performed in real property trades or businesses in which he materially participates; and (2) he performs more than 750 hours of services during that tax year in real property trades or businesses in which he materially participates. ( Code Sec. 469(c)(7)(B) )

If a taxpayer is a qualifying real estate professional, the PAL rules generally are applied as if each interest of the taxpayer in real estate were a separate activity. ( Code Sec. 469(c)(7)(A)(ii) ) For example, the determination of whether the taxpayer materially participates is applied separately to each interest. But, a real estate professional may elect to treat all his interests in rental real estate as one activity. ( Reg. § 1.469-9(g) )

Code Sec. 469(c)(7)(C) provides that the term “real property trade or business” means “any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.” These terms are not defined in Code Sec. 469 or the regs.

Facts. John is a state licensed real estate agent and works full-time as an independent contractor for a real estate brokerage firm. Under state law, he isn’t licensed as a real estate broker. John brings together buyers and sellers of real property and negotiates contracts of sale and other agreements between buyers and sellers of real property.

Mary is a state licensed mortgage broker. As a mortgage broker, she markets mortgage loans and brings together lenders and borrowers. Under state law, Mary’s mortgage brokerage business is considered to be a real property brokerage business.

CCA’s conclusion. Looking to legislative history and principles of statutory construction to determine the meaning of “real property brokerage,” IRS concluded that John, the licensed real estate agent, was engaged in a real property brokerage trade or business as described in Code Sec. 469(c)(7)(C) , but Mary, the licensed mortgage broker, was not.

Preliminarily, IRS noted that it has long been held that Federal law governs the construction of terms for Federal tax purposes. Accordingly, state law definitions of the terms “real estate agent” and “mortgage broker” were not determinative of whether a taxpayer was engaged in a real property brokerage trade or business for purposes of Code Sec. 469(c)(7)(C) .

IRS reasoned that the principles of statutory construction indicated that a mortgage broker wasn’t engaged in real property brokerage. Statutory words are presumed, unless it appears otherwise, to be used in their ordinary and usual sense, and with the meaning commonly attributed to them. Webster’s Dictionary defined “real estate” as “property consisting of buildings and land; the business of selling land and buildings,” and defined “brokerage” as “the business of a broker” or the “broker’s fee or commission.” Webster’s defined a “broker” as “a person who helps other people…to buy and sell property.”

Accordingly, IRS determined that the common and ordinary construction of “real property brokerage” for purposes of Code Sec. 469(c)(7)(C) involved bringing together buyers and sellers of real property. This definition didn’t include the brokerage of financial instruments. Thus, the “financing” of real property-such as by bringing together lenders and borrowers-wasn’t a real property brokerage trade or business under Code Sec. 469(c)(7)(C) .

In addition, IRS noted that although Congress initially included “finance operations” in the list of qualifying real property trade or business activities in an earlier, unenacted version of what would become Code Sec. 469(c)(7)(C) , (H.R. 3732, 101st Cong. (2d Sess. 1989), S. 2384, 101st Cong. (1989-90)), the term “finance operations” was removed from the final bill. (H.R. 2264, 103d Cong. (1993) (enacted)). It was therefore reasonable to infer that Congress didn’t intend for financing activities to constitute a real property trade or business and that financing activities shouldn’t be included in the definition of “real property brokerage.”