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What activities count and don’t count?
By Jason Watson (Google+)
In general, any work you do in connection with an activity in which you own an interest is treated as participation in the activity. Some of the activities that count towards your hourly requirements include collecting rent, bookkeeping, advertising, maintaining legal compliance, safety reviews, inspections, decorating, tenant approval, contractor supervision, procuring insurance, paying taxes, and actual hands-on maintenance.
There are some activities that do not count.
Travel: While you can deduct mileage and expenses for your travels to and from your rentals, the time spent traveling is considering commuting and therefore does not count towards your hourly thresholds. However, there is an IRS position asserted in Tax Court Memo 2012-83 (Trzeciak) allowing you to count the time spent traveling if you are also claiming a home office that is used regularly and exclusively for your real estate activities.
There is also some case law saying No. In Tax Court Summary 2003-130 (Truskowsky) unless a taxpayer can prove day-to-day managerial involvement, then travel time is considered commuting, which is personal in nature, and therefore does not qualify. This is a fairly grey area and more discussion is required.
If you did not claim a home office, you should assert that position on your tax returns right away. Home office suggests regular and exclusive use, and coupled with proof and day-to-day participation, travel time can be successfully argued.
Research: A lot of investors claiming real estate professional status attempt to fill in the holes of their hourly requirements and day-to-day involvement by suggesting research into other investment properties. While this sounds legitimate, the IRS and Tax Court has denied this position as investor activities and not real estate activities. Find something else to put on your time sheet- cut some grass, hunt and peck your QuickBooks entries, but don’t log Zillow hours.
Investor: You do not treat the work you do in your capacity as an investor in an activity as participation unless you are directly involved in the day-to-day management or operations of the activity. Work you do as an investor includes:
- Studying and reviewing financial statements or reports on operations of the activity,
- Preparing or compiling summaries or analyses of the finances or operations of the activity for your own use, and
- Monitoring the finances or operations of the activity in a non- managerial capacity.
Note that these activities are acceptable as long as you can demonstrate a day-to-day involvement with the activity. This is critical since it is presumptuous of the IRS to consider rental activities not requiring day-to-day involvement.
Spouse Participation: Remember, your material participation in an activity includes your spouse’s material participation. This applies even if your spouse did not own any interest in the activity and you and your spouse do not file a joint return for the year. Note the word material- you will need to demonstrate that your spouse’s time was material to the rental activity or operation.
There are several other horror stories, if you will, about investors and real estate professionals being denied time spent on various activities that seem real estate related. Some of those stories appear to hinge on the auditor, how they interact with the auditor, and simply bad information.