A rental real estate activity is subject to the passive loss limitation rules. Thus losses from this type of activity may be restricted, meaning that a taxpayer often cannot use the losses to offset non-passive income from sources such as wages, interest, and dividends. One exception to this rule is when the taxpayer qualifies as a real estate professional.
A real estate professional is a taxpayer who performs (1) more than half of his/her personal services in real property trades or businesses in which the taxpayer materially participates; and (2) such time exceeds 750 hours.
What many real estate professionals do not realize is that the 750 hour test must be met for EACH rental property held by the taxpayer, unless a special tax election is made. Thus for a real estate professional who owns several rental properties, meeting the 750 hour test can become an impossibility unless the special tax election is made.
The burden of proving that 750 hours was spent on real estate trades or businesses is on the taxpayer, and if audited by the IRS, the taxpayer will need to produce a contemporaneous log book. In a recent court case (O’Neill, T.C. Summary Opinion 2015-27, April 13, 2015), the taxpayer produced the contemporaneous log book, but the IRS refused to accept that the taxpayer was a real estate professional because the number of hours fell short of 750. The taxpayer then submitted a revised log book showing that the hours exceeded the 750 hour threshold. However, the IRS refused to accept that log book because it was not contemporaneous . . . it had been revised after the fact. The Tax Court ruled in favor of the taxpayer because the log book was well documented and it was obvious that the taxpayer did not include travel between her rental properties when logging in the hours. When the travel time was included, the 750 hour test was met.
When reading a tax court case, it is always a good idea to look at the lessons learned. In this case, (1) the election to treat the taxpayer’s 12 rental properties as one was not an issue as the taxpayer made the special election; (2) the IRS and the Tax Court agreed that the taxpayer would not meet the 750 hour test if the log book was not contemporaneous; (3) reasonable travel time between rental properties is part of the 750 hour test; and (4) math corrections to the log book can be made after the fact.
If you want to learn more about tax preparation services or tax planning strategies (including the special tax election mentioned above), we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.