Ever since ’86, when the “passive activity loss” limitation rules hit the street, they have been an annoyance (to say the least) to most taxpayers — except in the case of the “real estate professional,” to whom the limitations may not apply.
So for many, the question arises as to how one actually qualifies as a real estate pro. Some do; many don’t.
A taxpayer qualifies if:
• More than half of the personal services he performs during the year are performed in real property trades or businesses (including, among others, development, construction, conversion, rental, management or brokerage) in which he materially participates, and
• He or she performs more than 750 hours of services during the tax year in real property trades or businesses in which he materially participates.
The extent of one’s participation may be established by any reasonable means — contemporaneous daily time records are not required (though are desirable as noted below) if the extent of participation can be established by other reasonable means.
In case you’re wondering, the “reasonableness” standard isn’t so loosey-goosey as to permit a “ballpark guesstimate,” says the Tax Court.
So in 2008, here come Mr. and Mrs. Adeyemo — she had a full time job; he performed 1,500 hours of work in his job as a pharmaceutical sales rep.
In addition, these folks were the owners and managers of seven rental properties. Mr. A did the bulk of the work, as there was no outside management company in the picture.
The activities he conducted included, among other things, actually maintaining and repairing the properties, overseeing maintenance crews, showing the properties to prospective tenants, collecting the rents, and when necessary, bringing eviction actions against the tenants.
Despite all of this, IRS found that Mr. A didn’t rise to the level of a real estate professional, and the Tax Court has recently agreed.
First of all, the fact that his work relative to the real estate accounted for no more than 800 hours meant that he spent less than half of his total personal service time (1,500 + 800 = 2,300/2 = 1,150) in the real estate business. And in 2009, the 715 hours he spent was less than the 750 hour minimum required by the law.
Further, what also confounded the taxpayers was their recordkeeping, which consisted of a log book, a spreadsheet prepared for the Tax Court encounter, and testimony.
The log book was helpful, and the Court agreed that it portrayed an accurate account of Mr. A’s activities, in support of the 800 and 715 hour commitments asserted for each of the tax years.
At trial, however, trying to embellish the record, Mr. A opined that the log book actually reflected on a portion of the real total hour number for each year, which is why he created the spreadsheet, albeit several years after the fact and just before the trial.
He was unsuccessful, however, in convincing the Court that the spreadsheet was more comprehensive than the log book because, among other things, the Court found that the times and activities listed in the spreadsheet were inconsistent with the taxpayers’ oral testimony and/or their documentary evidence.
Moral of the story? Keep detailed and accurate records as you go, rather than trying develop the rosy picture for the auditors when they later come calling.
CONSULT YOUR TAX ADVISER — This article contains general information about various tax matters. You should consult your CPA regarding the implications to your own particular situation. Jeff Quinn is a shareholder in Ashley Quinn, CPAs and Consultants, Ltd., with offices in Incline Village and Reno. He can be reached at email@example.com.