Programming note. The Tax Update goes untended for the next two weeks, as I head to Philmont Scout Ranch with my younger son and others for a 10-day backpacking odyssey. It’s my first visit to New Mexico and my first extended backpacking trip. Horses, carabiners, and black powder rifles will be encountered. Whatever remains of me will be back here July 28. The lovely and talented folks in the blogroll to the right will keep the tax world under control in the meantime.
Accounting Today visitors: if you followed the newsletter link here, you probably are looking for this: July 5, 1944.
Does the tax law cause people to do work on rental properties that they really should hire out? That’s one conclusion you could draw from a Tax Court case yesterday, where a landlord says she chose do herself work that, based on the time she says she spent, should have gone to a contractor.
The tax law says real estate losses are normally “passive,” and when adjusted gross income exceeds $150,000, they are only deductible to the extent of other passive income. A special rule lets “materially participating real estate professionals” out of the “per-se passive” rules; these taxpayers test whether their real estate activity is passive under the rules that apply to other business activities, based on time spent.
There’s a serious catch. To qualify as a real estate pro, you have to work at least 750 hours in real estate, and more hours than in anything else you do. If you have a full-time day job, this doesn’t work.
Petitioner claimed to have spent a total of 772 hours working on her rental properties in 2009. In support of her assertion, petitioner provided activity logs purporting to document the time she spent on her rental activities. Some of the activities included painting, cleaning apartments, shoveling snow, communicating with tenants on various issues, placing rental ads in the local newspaper, picking up mail, and paying bills. Although some log entries reference a specific apartment or property, many log activities do not specifically identify a particular rental unit. In addition, the number of hours noted on petitioner’s logs appears to be significantly inflated. For example, in one instance petitioner claims to have spent 8 to 12 hours per day for 10 days staining the “deck and siding” of what appears to be one apartment at the Pulaski property.
Some people just are perfectionists.
The log also indicates that [petitioner's husband] helped stain the deck and siding on those dates. In that instance, petitioners together spent between 160 to 240 hours staining the deck and siding of one apartment. There are several other instances in 2009 where petitioner claims to have spent many hours staining and painting decks and front porches of the rental properties. Petitioner’s log for July 2009 indicates that she spent approximately 77 hours over an eight-day period to paint a back porch. Petitioner’s log for November 2009 indicates that she spent more than 105 hours over a 12-day period on the flooring for one apartment and that on one specific day she worked 16 hours.
While a misguided attempt to reach 750 hourse might have motivated this sort of effort, the judge decided that something else was going on:
Although petitioner claims she acted reasonably and in good faith with respect to her position that she was a real estate professional in the years in issue, we have concluded that petitioner’s records are not accurate or reliable and likely inflated the hours she spent in real estate activities. We have also concluded that the logs relating to her activity as an employee and her self-employment were not accurate.
If you want to document time for showing an activity is non-passive, it is wise to track it in a daily contemporaneous calendar. It is also wise to not push the limits of believability.
Material participation hours tests can be found here.
TaxProf, The IRS Scandal, Day 428. It features from the Wall Street Journal U.S. Judge Orders IRS to Explain How it Lost Lerner’s Emails:
A federal judge on Thursday ordered the Internal Revenue Service to explain how it lost two years’ worth of a former official’s emails, and tapped a magistrate judge to find out whether the documents can be obtained from other sources.
At a hearing in a conservative group’s lawsuit, U.S. District Judge Emmet Sullivan gave the IRS until Aug. 10 to provide a sworn declaration explaining how the email loss occurred. The IRS previously has said that the emails were lost because the top agency official’s computer crashed in 2011, and backup tapes were routinely reused after six months.
These practices violated federal recordkeeping procedures and, likely, federal law. In spite of Ms. Lerner’s evident concern about the possibility of her emails being found, Commissioner Koskinen says it’s silly to think anything more suspicious than a remarkable rash of hard-drive failures is to blame.
A new study by the Mercatus Institute says state taxes matter. A summary says “The study finds that higher state taxes correlate with lower economic performance, even when controlling for various factors.” It says that higher taxes lower economic growth, affect migration patterns, and reduce business startups. (hat tip: Maria Koklanaris, State Tax Notes ($link‘))
Carl O’Donnell, How The $1 Billion Kennedy Family Fortune Defies Death And Taxes. Most politicians who vote for higher taxes do so assuming they won’t have to pay them. (via the TaxProf)
Jim Maule continues his Tax Myth series with Tips Aren’t Taxed Because They Are Gifts. “Most people who collect tips are paid very little, rely on the tips to make a living, and are unhappy to learn that tips are included in gross income.”
Jason Dinesen, Glossary of Tax Terms: Head of Household
It’s Friday, it’s Buzz Day at Robert D. Flach’s place.
Keith Fogg, Revoking the Release of the Federal Tax Lien and Appointing a Receiver (Procedurally Taxing)
TaxGrrrl, Who Should Pay For Schools? Answer Remains Unclear As Cigarette Tax Boost On Hold Smoke ‘em if you got ‘em. For the children!
Renu Zaretsky, Games, Spins, Ignorance and Patience. Today’s TaxVox headline roundup covers, among other things, Highway Trust Fund games, corporate inversions.
Steve Warnhoff, House Poised to Throw $276 Billion “Bonus” at Businesses. (Tax Justice Blog). He’d rather throw it at the government.
I’ll bet he does. Beanie Babies creator defends sentence of probation, no prison time, for tax evasion (Brandon Sun)
News from the Profession. Just How Many CPA Roommates Can You Fit In a Single Apartment? (Leona May, Going Concern)
Tags: Carl O'Donnell, cavalcade of risk, Hank Stern, Jason Dinesen, Judge Panuthos, Kay Bell, Keith Fogg., Kyle Pomerleau, Leona May, Maria Koklanaris, News from the Profession, Renu Zaretsky, Robert D Flach, Steve Warnhoff, tax court, TaxProf