Sheldon! The Day 1 ISU Center for Agricultural Law and Taxation Farm and Urban Tax Schools team is in Sheldon, Iowa today, while another crew takes care of Day 2 in Waterloo. Today’s session is at Northwest Iowa Community College, where about 1,900 students study programs ranging from pre-professional accounting to powerline technology. It’s not exactly an urban setting:
It’s always a great crowd, and it’s good to see everyone again. Especially since it’s not freezing here yet this year.
Accounting firm real estate appraiser flunks real estate pro test. It’s not easy for someone with a day job to be a “real estate professional” under the tax law “passive loss” rules. Passive losses are only deductible to the extent of passive income, and are otherwise deferred until a taxable sale of the “passive activity.” Real estate rental losses are automatically passive for most taxpayers, but an exception allows “real estate professionals” to qualify as non-passive under the same rules that apply to other businesses.
You have to clear two hurdles to be a real estate pro:
- You have to work more than 750 hours in real estate businesses in which you have an ownership interest, and
- Your real estate time has to exceed the time you spend doing everything else.
The second qualification eliminates most taxpayers with day jobs. But that didn’t stop our intrepid appraiser, who worked for two top-ten accounting firms in their appraisal practices.
The taxpayer and his wife acquired several apartments over the course of their marriage, which they claimed losses based on the real estate pro provision. The Tax Court sets the stage; I change the taxpayers’ names to “Mr. Taxpayer” and “Mrs. Taxpayer” in my excerpts, and all emphasis is mine.
Petitioners were married in 2006. At that time Mrs. Taxpayer owned a single condominium (Unit 918) which she had previously used as her personal residence. Mr. Taxpayer owned two condominiums (Units 522 and 801), one of which he had previously used as his personal residence. Each unit was subject to a separate mortgage. When petitioners married, they pledged the three units as collateral and obtained a loan to purchase an additional condominium (in the same building as Units 522 and 801) for use as their new personal residence.
Beginning in 2006 and throughout the year in issue, petitioners operated Units 522, 801, and 918 as rental properties. The parties stipulated that petitioners did not hire a property manager to assist with their rental properties in 2010.
Mr. Taxpayer’s reliance on work that he performed for Grant Thornton and Crowe Horwath to show that he qualified as a real estate professional in 2010 is misplaced. In short, he testified that he did not own an equity interest in either firm, and he did not offer any other evidence in support of the proposition that he met the definition of a “5-percent owner” of either firm within the meaning of section 416(i)(1)(B). Therefore, the personal services that he performed as an employee of those firms may not be taken into account in computing the number of hours that he performed personal services in real property trades or businesses.
The wife had a better argument, but the court was unpersuaded by her evidence of working 750 hours:
Petitioners’ testimony was inconsistent regarding the division of labor between them and the timing of significant events. As to the division of labor, Mr. Taxpayer stated, quite candidly we believe, that Mrs. Taxpayer did little physical labor after the birth of their son in late November 2009. In contrast, Mrs. Taxpayer testified (and her revised log indicates) that she spent many long days in the first weeks of January 2010 cleaning, painting, and repairing Units 522 and 801.
Against this backdrop, we bear in mind that Mrs. Taxpayer did not maintain a contemporaneous log of her rental property activities and instead made handwritten notes on scraps of paper that she did not review in any great detail until a few weeks before trial. A close examination of the revised log that she submitted to respondent’s counsel raises serious doubts about its accuracy… for the period January 2 to January 11, Mrs. Taxpayer’s revised log indicates that she worked at least 154 hours — an average of slightly more than 15 hours per day for the 10-day period — not counting any time that she may have spent showing either unit to prospective tenants. We find it improbable that Mrs. Taxpayer performed all of the work described above.
While I admire anyone who can work 15-hour days within two months of giving birth, the Tax Court’s admiration was at best tempered by poor recordkeeping. Decision for IRS, with 20% “accuracy related” penalties tacked on.
The Moral? If you need to prove your time spent for business activities, there’s nothing better than a current time log. “Scraps of paper” are a poor substitute.
Related: Material participation basics.
Robert D. Flach comes through with an “especially ‘meaty'” Buzz today. LInks to much tax blog goodness, with free analysis of Donald Trump, no extra charge.
Russ Fox, Cleveland Loses on Monday (and They Didn’t Even Play). The Supreme Court rejected an appeal of rulings that its “Jock Tax” is unconstitutional.
William Perez, The Key Benefits of Health Savings Accounts
Renu Zaretsky, A Debate, A New Plan, A Vote, and Two Mulligans. Today’s TaxVox headline roundup covers the GOP debate, the Carson tax plan, and TurboTax’s plans for the coming filing season.
TaxProf, The IRS Scandal, Day 915
A vital clue. While leading the class yesterday in Waterloo, co-presenter Roger’s phone was buzzing frantically in his pocket while he was speaking. As it turns out, Mrs. Roger had received a message on her anwering machine at home saying the IRS needed to talk to her immediately. She called the number that was left, and somebody answered, telling her the police would arrest her right away if she didn’t pay her taxes.
Roger related the story to the class, and one of the attendees immediately pointed out the sure clue that it wasn’t really a call from the IRS:
“Somebody answered the phone.”