How Real Estate Pros Can Use IRS Section 469 to Offset Taxes With Rental Losses
If you’re in real estate—whether as an agent, investor, or business owner—you’ve likely encountered the frustrating limits around passive losses. You might own rental properties that are operating at a loss, but those losses just sit there because they can’t offset your ordinary income.
What if you could change that?
There’s a little-known strategy built into the tax code that allows you to do exactly that. It’s called Grouping of Activities under IRS Section 469, and it could be a game-changer for your tax planning.
What Is Grouping of Activities?
Section 469 of the Internal Revenue Code allows taxpayers to combine related business and rental activities into a single “economic unit”. When done correctly, this grouping lets you apply passive losses (such as those from rental properties) directly against non-passive income (such as income from a real estate business or operating company).
This is particularly valuable if you’re earning substantial income in one area of your real estate portfolio but suffering losses in another.
Who Can Benefit From This?
This strategy is best suited for:
- Realtors who also invest in rental properties
- Real estate investors with multiple properties
- Business owners who own both an operating company and the building it occupies
- Anyone with passive losses and active business income related to real estate
Common Scenarios Where Grouping Can Save You Money
Scenario 1: Operating Business + Rental Property
Imagine you own an HVAC company structured as an S-Corporation, and that business rents space from a separate LLC or partnership you also control. Normally, any losses from the rental property would be considered passive and restricted.
But if you group the business and the rental property, you can deduct those passive rental losses against the active income from the HVAC business—potentially reducing your taxable income significantly.
Scenario 2: Realtor + Rental Properties
Say you’re a real estate agent earning income via a K-1 from your brokerage. You also own several rental properties through separate partnerships. Under normal rules, your rental losses can’t offset your active income from commissions or brokerage profits.
With grouping, however, those losses may become deductible against your ordinary income if the businesses meet the IRS requirements for being part of the same economic unit.
How Does the IRS Define an “Economic Unit”?
To legally group activities, the IRS looks at several factors to determine whether they operate as one economic unit:
- Similar types of customers or tenants
- Shared facilities or operational interdependencies
- Activities located in the same geographic area
- Common management or ownership structure
For example, one investor grouped three rental properties in Orlando because they had the same tenant type, were in the same city, and were all managed together. By grouping them, she was able to maximize deductions and potentially convert passive losses into non-passive losses—unlocking tax savings that weren’t available before.
Key Benefits of Grouping Activities
- Offset Passive Losses: Apply rental losses to reduce business income
- Satisfy Material Participation Tests: Help meet the criteria to reclassify activities as non-passive
- Improve Tax Efficiency: Structure real estate portfolios to reduce taxable income year after year
Risks and Considerations
While grouping can be powerful, it’s not without complexity:
- Once grouped, activities generally must remain grouped unless there’s a qualifying “material change” in operations.
- Some deductions may only provide temporary benefits, reversing in future years.
- Improper grouping or documentation can draw IRS scrutiny.
In other words, this isn’t a DIY tax move. It’s best implemented with guidance from an experienced tax advisor who understands real estate and the nuances of Section 469.
Steps to Implement This Strategy
- Review all your business and investment activities to identify potential groupings.
- Determine if activities form a legitimate economic unit under IRS criteria.
- Evaluate material participation—does grouping help you meet the required hours of active involvement?
- Make a formal election on your tax return and document your reasoning.
- Reassess periodically, especially after acquisitions, sales, or business changes.
Final Thoughts
If you’re a real estate professional or investor with both profitable and underperforming assets, grouping activities under Section 469 may allow you to unlock tax savings that would otherwise be trapped. By combining your related business and rental operations into a single tax entity, you can turn passive losses into real, usable deductions.
This is a sophisticated strategy—but for the right real estate profile, it can deliver significant value. Work with your tax advisor to determine if it’s a fit for your business model.
