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Real Estate Professionals Must Put in the Time

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Unless you qualify as a real estate expert, tax restrictions are generally a deduction for passive loss of activity (PAL) from real estate. To measure, you must be able to prove that you have spent enough time on real estate activities. In a new case, Sezonov, TC Memo 2022-40, 4/20/22, taxpayers were in short supply, even if the tax court gave him suspicious interests.

Background: As a general rule, investors in activities that are virtually non-participating, such as real estate, can only deduct up to the amount of “passive income” for the year. Therefore, although the amortization of PAL allowed to “active participants” real estate investors is limited, annual losses cannot be claimed. Generally, you can use up to $ 25,000 in losses to offset your non-passive income. This $ 25,000 offset will be phased out against MAGI’s Adjusted Gross Income (MAGI) between $ 100,000 and $ 150,000.

However, once your real estate activity reaches the level of a real estate professional, you can deduct losses from your non-passive income, just like any other business. There are two important requirements to qualify as a real estate expert.

1. More than half of the personal services performed in all transactions or businesses during the tax year are conducted in the real estate transactions or businesses in which you are substantially participating.

2. You must spend more than 750 hours on your real estate transaction or business.

Substantially participating real estate activities are not treated as passive activities as long as they meet this two-part test. The IRS often disagrees with these types of claims, so be prepared to provide reasonable evidence.

New Case: A taxpayer resident in Ohio was the only member of a limited liability company (LLC) in which he ran a wholesale HVAC business. He ran a full-time business from 2013 to 2014 without employees.

In 2013, the company bought two rental properties in Florida. The taxpayer and his wife rented both properties during the two tax years in question (after temporarily leasing one property to the previous owner) while continuing to live in Ohio.

The taxpayer’s wife promoted the rental property in Florida and contacted the lessor and future lessors by email. In between rentals, she cleaned and prepared for the next lessor, or hired a cleaning service for work. The taxpayer helped reply to emails and maintain and repair the property, but her wife was in charge of day-to-day management.

The couple did not maintain a simultaneous record of working hours in a Florida rental property. However, while their proceedings were pending in the tax court, the taxpayer’s wife created a time log that estimates the time both worked on the property.

After taxpayers deducted all losses from Florida real estate rents each year, the IRS challenged the issue and assessed the flaws.

Tax Results: The couple’s records management was unsightly, but at best it wasn’t really a problem. Even if the tax court accepted the logs, they said they weren’t totaled anywhere near 750 hours. As a result, the loss deduction was rejected.

The lesson of the story: To qualify as a real estate expert, you must be able to “take the time” and prove it through records management at the same time. Diligently: The IRS is on the lookout for exaggerated claims by other full-time workers.

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