Tax Roundup, 3/17/16: Brokering mortgages isn’t “real estate activity,” says Tax Court. And: Irish scenery!

March 17th, 2016 by Joe Kristan
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All photos today courtesy Dan Kristan

Sometimes training isn’t enough. A taxpayer whose case was decided this week in Tax Court seems well equipped to fight the IRS:

Petitioner holds a bachelor of science degree in accounting and a master’s degree in tax law. During each year in issue petitioner was licensed in California as a real estate broker and was qualified to represent taxpayers before the Internal Revenue Service (IRS) as an enrolled agent.

A specialized tax degree and an E.A. designation is pretty strong background, but credentials don’t always get the job done.

The taxpayer’s business involved mortgage brokerage, real estate brokerage, and tax preparation. The taxpayer argued that the time he spent as a mortgage broker counts as a “real estate trade or business,” enabling him to treat rental losses as non-passive and therefore deductible.

Some background. The tax law treats rental losses for most taxpayers as automatically passive, and therefore deductible only to the extent of “passive” income or at the time the “passive activity” is sold.

Business activities other than real estate rental are not automatically passive. Taxpayers can avoid the passive loss rules if they “materially participate” in the activity. This is based on the amount of time spent on the activity.

If you qualify as a “real estate professional,” your real estate losses are not automatically passive; they are tested as passive or non-passive based on the tests used for other businesses. But it is hard to be a real estate pro under these rules:

-You have to spend at least 750 hours a year working in a “real estate” trade or business, and

-Your real estate time has to exceed the time you spend doing non-real estate work.

This second test keeps most people from being real estate pros, as its hard to convince the IRS or the courts that you have a 2000-hour full time job but that you spend more time than that managing real estate.

The taxpayer in this case said his mortgage brokerage was a real estate business:

According to petitioners, petitioner’s mortgage brokerage activity is a “real property trade or business” within the meaning of section 469(c)(7)(C). Petitioners go on to argue that because petitioner spent more than 750 hours providing services in connection with his mortgage brokerage business for both years in issue, and because he spent more time in that business than he did in any other trades for business during each of those years, for both years in issue he is a [real estate professional]…

This is the first time I’ve seen mortgage brokering treated as a “real estate” trade or business. The Tax Court ponders the question (my emphasis):

Section 469(c)(7)(C) defines a real property trade or business to mean “any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.” Petitioners focus on the word “brokerage” contained in that section and argue that petitioner’s mortgage brokerage business is contemplated by the statute. We disagree. Petitioners’ argument ignores the words “real property” that precede the specific activities listed in the statute; those words modify each of those activities. While petitioner’s mortgage brokerage activity constitutes a “brokerage” trade or business, it does not constitute a “real property brokerage” trade or business. Petitioner was not during either year in issue brokering real estate; he was brokering financial services.

The court was unconvinced that the taxpayer met the 750-hour test without counting the mortgage brokerage time, so the rental losses were passive and disallowed. The issue was novel enough, though, for the taxpayer to avoid penalties.

The Moral? Credentials are helpful to a tax preparer, but they aren’t always enough to convince the Tax Court to see things your way.

Cite: Guarino, T.C. Summ. Op. 2016-12.

 

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Scott Drenkard, Sights and Sounds from Kansas as they Consider Bill to Eliminate Pass-through Carve-out:

Kansas is on the right track by broadening its tax base and lowering its rates, but should be cautious about favoring some businesses over others. A better path to encouraging economic growth is creating a tax environment that is not overly burdensome and treats all businesses well. Further, while tax reductions can have positive economic benefits, they will cost revenue and will ultimately have to be paid for either by cutting spending or increasing taxes elsewhere.

If Iowa ever gets around to much-needed business tax reforms, Kansas will provide a good bad example.

 

TaxGrrrl, 7 Options To Consider When You Can’t Pay Your Tax Bill In Full. With this importand advice: “What if you know that you can’t pay what you owe? File anyway.

Robert Wood, Before Filing Your Taxes With IRS, Consider This. “As you start preparing to file your tax return this year, consider what will happen if you are audited.”

Keith Fogg, A Different Type of Offset Fight – Illegal Exaction (Procedurally Taxing). “In the end, this type of case appears extremely difficult to win which is why so few of these cases make it to published opinions.”

Paul Neiffer, IRS Interest Rates Finally Start to Rise. “It seems like forever that the interest that the IRS will pay or collect on tax refunds/underpayments has been stuck at 3%.  The IRS just announced today that beginning April 1, 2016, the interest rate will rise to 4% for most taxpayers.”

Kay Bell, New tax scam alert: Cons posing as fake IRS agents now calling to ‘verify’ filers’ tax return information

 

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TaxProf, The IRS Scandal, Day 1043

Renu Zaretsky, Caution, Cuts, and a Chunk of Change. Today’s TaxVox headline roundup covers budget battles in Minnesota and proposed corporate tax cuts in the U.K., among other things.

 

Career Corner. Study: Women Even Less Willing to Put Up With Crappy Pay Than Men (Caleb Newquist, Going Concern)

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