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What are some of the tax court cases for real estate professionals?
By Jason Watson
Here is a snapshot of some issues the Tax Court has recently dealt with.
Taxpayer was a real estate agent who attempted to deduct several travel expenses including Hawaii and Lake Tahoe. He attempted to claim the travel was for investment purposes by researching additional real estate, but his recordkeeping was shoddy and was denied the deduction.
Taxpayer claimed that time traveling to and from rental properties added to the 750-hour and material participation requirements. IRS agent and Appeals officer said No. But it appears from the court records that perhaps the IRS would entertain travel time had the taxpayer asserted a home office deduction for rental property activities. The Tax Court was dealing with a different issue, and did not address this on point.
TC Summary 2003-130 (Truskowsky)
Unless a taxpayer can prove day-to-day managerial involvement, then travel time between a taxpayer’s house and the rental activity is considering commuting and therefore does not qualify towards the hourly requirements for real estate professional and material participation. Commuting according to IRC 162 is not deductible. Sorry.
In terms of recordkeeping and proving hourly involvement, the Tax Court has acknowledged that “reasonable means” is interpreted broadly. Nevertheless, a postevent “ballpark guesstimate” will not suffice. Leave it to the Tax Court to bust out some slang.
Tax Court Memo 1998-17 (Pohoski)
Court stated the second test of material participation was not satisfied when taxpayers failed “to put forth some indication of the actual time spent by” third-party non-owners such as property management companies.
To push the taxpayers over the 100-hour hurdle, petitioners introduced at trial three revised logs, including a last-minute log purporting to be a reconstruction of the hours of services Mr. Manalo performed with respect to the rental activities. The estimates in these revised logs, however, were uncorroborated and unreliable. The revised logs were prepared at various instances over a two-year period after the conclusion of IRS agent’s examination and are, according to petitioners, based on emails and archived documents. Those emails and archived documents, however, were never introduced into evidence at trial. The Tax Court stated “The rule is well established that the failure of a party to introduce evidence within his possession and which, if true, would be favorable to him, gives rise to the presumption that if produced it would be unfavorable.” Yuck!
Taxpayer used hourly estimates that varied throughout trial. Tax Court considered this a postevent “ballpark guestimate” and denied the real estate professional designation.
For those rental property owners who do elect or do not need to elect the real estate professional status only need to show active participation. The active participation standard can be satisfied without regular, continuous, and substantial involvement in an activity; the standard is satisfied if the taxpayer participates in a significant and bona fide sense in making management decisions (such as approving new tenants, deciding on rental terms, approving capital expenditures) or arranging for others to provide services such as repairs.
Taxpayer was a pilot who worked for American Airlines, and worked 812 hours according to timesheets provided. Taxpayer was not able to prove that he spent more than 812 hours on his real estate activities. More importantly he failed to make the election to treat all rental properties as a single activity.
The spouse was a licensed real estate agent while the taxpayer (the husband) worked on the rental properties. The Tax Court found that they satisfied test #2 of the material participation tests since their participation in the rental real estate constituted substantially all of the participation. Mr. Fitch testified extensively as to the activities he performed with respect to his rental properties including advertising, bookkeeping, accounting, dealing with contractors, decorating, resolving fence disputes, making repairs, paying taxes, and procuring insurance. The petitioners’ decision to occasionally hire a contractor to perform technical tasks does not disqualify their substantial day-to-day management of their rental properties from constituting “substantially all of the participation”.
Tax Court allows a limited partner in a partnership to count that time towards material participation. Generally limited partners on paper cannot by definition materially participate, however, the actions of the taxpayer actually suggested a general partner and not a limited partner. The taxpayer eventually lost on the 750-hour rule for real estate professional.