United States

Recent case shows benefit of record keeping when claiming rental loss

Taxpayer records support taxpayer’s real estate professional assertion

TAX ALERT  | 

In a memorandum opinion, the Tax Court recently sided with a married couple (see Roberta Birdsong, et ux. v. Commissioner), agreeing that the wife’s rental losses were not limited by the passive activity loss limitations because she presented sufficient evidence supporting her assertion that she was a real estate professional and that she materially participated in the activities.

Generally, a taxpayer may not deduct net losses from passive activities, including rental real estate activities. There is, however, an important exception for “qualified real estate professionals.” Specifically, individuals who (a) devote over one-half of their personal services in a particular year to real property trades or businesses, and (b) perform more than 750 hours of services in those real property trades or businesses can deduct losses from a rental real estate activity to the extent they materially participate in the rental activity. Substantiation of the hours spent on such activities is often a point of contention between the IRS and taxpayers, and was the key issue of this case.

In Birdsong, the taxpayers owned two rental real estate properties. The husband was a full time emergency physician, and the wife – while not formally employed – divided her time between caring for their children and managing the rental properties. On their tax return for the tax year at issue, the couple asserted that the wife qualified as a real estate professional and reported a loss from their rental activities. The IRS issued a notice of deficiency, disallowing the rental loss.

In its decision, the Court noted, and the IRS agreed, that the wife passed the first prong of the qualified real estate professional test, as she was not otherwise employed during the year. The remaining question was whether she performed more than 750 hours in those activities.

The wife was the only party involved in the day-to-day management of the properties – activities that included cleaning common areas, performing repairs, communicating with tenants, collecting and depositing rent, paying bills, and hiring outside contractors to perform certain tasks, among other things. The Court found as credible both the husband and the wife’s testimony of the wife’s active and extensive management of their rental properties. Moreover, the Court found the supporting documentation – detailed spreadsheets reflecting the wife’s management activities along with thorough time-keeping entries and receipts to corroborate her time logs – persuasive. Based on the testimony and supporting documentation, the Court concluded that the wife met the requirements to be a real estate professional and allowed the loss.

While this case does not raise unique issues in this area, it does serve as a reminder of the importance (or, perhaps more importantly, the benefit) of maintaining detailed records supporting the time devoted to a business. In cases where the IRS raises participation questions, contemporary logs are among the most persuasive pieces of evidence.

For more information on qualified real estate professionals, see our previous alert: Tax Court denies taxpayer’s loss on real estate activities.

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