Home Builders' Association Criticizes Pal Regs.

The National Association of Home Builders, Washington, has

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May 11, 1995

CC:DOM:CORP:T:L:R:(PS-80-93)

Re: Proposed Rules for Certain Rental Real Estate Activities

Ladies and Gentlemen:

The National Association of Home Builders (NAHB) is writing this letter to provide comment on the proposed regulations pertaining to the Passive Activity Loss rules of Internal Revenue Code Section 469(c)(7), issued January 9, 1995. NAHB believes that the proposed regulations would, in effect as applied to builders and developers, countermine the underlying purpose of the statute. Accordingly, we urge reconsideration and revision of the proposed regulations.

GROUPING RENTAL REAL ESTATE ACTIVITIES WITH OTHER ACTIVITIES

Section 469(c)(7), enacted as an integral part of the economic stimulus package contained in the Omnibus Budget Reconciliation Act of 1993, was intended to level the playing field for real estate businesspersons. By enacting section 469(c)(7), Congress intended to alleviate the unfairness that a person who performs personal services in a real estate trade or business in which he materially participates could not offset losses from rental real estate activities against income from nonrental real estate activities. We believe the proposed regulations are not consistent with Congressional intent.

Specifically, proposed Regulation Section 1.469-9(e)(3) provides that a qualifying taxpayer may not group a rental real estate activity with any other activity of the taxpayer. It goes on to state, by way of example, that if a 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, and that only the taxpayer's participation in rental real estate may be used to determine if the taxpayer materially participates in the rental real estate activity.

In the usual instance, land developer/owners and builder/owners operate as fully integrated businesses. The taxpayer usually would utilize limited partnership or limited liability company entities to construct and own the properties, while consolidating management in a separately owned management company, for liability purposes. That is, the development, construction and rental of the properties are not treated as separate segments of the overall business operation. The taxpayer's rental and non-rental activities would be integrally related, and as with other businesses, should be counted towards determining material participation.

NAHB believes that the proposed regulation prohibits real estate developer/owners and builder/owners from using the most appropriate, reasonable and, in a business sense, practical method to group their operations to accurately measure gain or loss. As a result, for taxpayers involved in development and construction operations, the regulations do not alleviate the unfairness which Congress intended.

We urge you to revise Proposed Regulation Section 1.469-9(e)(3) to remove the artificial distinction between the rental and non- rental operations of taxpayers involved in development and construction operations.

EMPLOYEES IN REAL PROPERTY TRADES OR BUSINESSES

Proposed Regulation Section 1.469-9(c)(4) requires that an employee be a five-percent owner (within the meaning of section 416(i)(1)(B)) in the employer at all times during the taxable year in order to count personal services time towards real property trade or business time. We believe the requirement that the ownership interest be maintained "at all times" during the year is severe, and would operate to unduly limit availability of the relief the statute was intended to provide. We would ask that the provision be modified to require a lesser period of ownership time.

CONCLUSION

For taxpayers involved in development and construction operations, the proposed rules would retain the unrealistic, and unfair, separation between rental and non-rental operations, which Congress intended to remedy. As currently drafted, the proposed regulations significantly reduce the impact of the statute and do little to place builders and developers on the level playing field Congress intended.

We appreciate the opportunity to provide these comments.

If you have any questions with respect to this letter, please do not hesitate to contact J. Leon Peace, Jr., Tax Counsel of the National Association of Home Builders at (202) 822-0470.

Very truly yours,

National Association of