Source: https://www.goldinglawyers.com/real-estate-professional-exemption-irs-audit-tax-audit-representation-lawyers/
Timestamp: 2018-03-19 20:34:35
Document Index: 348253602

Matched Legal Cases: ['§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 469']

Real Estate Professional Exemption IRS Audit – Tax Audit Representation Lawyers
Home IRS Real Estate Professional Exemption IRS Audit – Tax Audit Representation Lawyers
The Real Estate Professional Exemption is one of the most debated IRS tax laws to date. The reason why is because real estate is still the top choice of investment for a broad range of different investors, including individuals, businesses, trusts, foreigners, etc..
The general rule is that a person may deduct a certain amount of costs associated with owning a rental property if they “actively” participate in the activity. For example, if David owns a rental property worth $500,000 and he has a $400,000 mortgage, $200 a month in HOAs, property taxes of $5000 a year in depreciation around $10,000 a year remaining, David can take these deductions against his general income.
Real Estate Professional Exemption
The problem with the above referenced analysis is that the deductions maxed out once a couple earns $100,000. For example, if a couple earns $125,000 MAGI (Modified Adjusted Gross Income), then they can only take a $12,500 deduction. Once a couple reaches $150,000 of income, they can no longer use the exemption.
As a result, individuals try to claim they are “Real Estate Professionals” in order to try and claim an unlimited deduction. For example, if a person qualifies as a real estate professional that it will not matter whether they make $100,000 or $500,000, they will not be limited in their losses.
The problem is that it is very difficult to qualify for the professional exemption. The IRS recently updated information regarding the professional exemption, which is provided below for you:
Passive Activity Loss ATG – Chapter 2, Rental Losses
Publication Date – December, 2004
A real estate professional must materially participate ineach rental activity for the loss to be deductible.[3]
Look at the taxpayer’s occupation next to the signature block and Schedule E line 43. To be a real estate professional, the taxpayer must spend the majority of time[5]in real property businesses and/or rental real estate.
More than 750 hours of service during the year.[6]
Finally, before rental losses are deductible without being limited by the passive losses rules, the taxpayer must materially participate in each rental.[7]
Request and closely examine the taxpayer’s documentation regarding time. The taxpayer is required under Reg. § 1.469-5T(f)(4) to provide proof of services performedand the hours attributable to those services. See Chapter 4 for more on methods of proof.
A real estate professional may deduct rental real estate losses only to the extent he or she materially participates in each rental activity. Unless the taxpayer elected to group his rentals as a single activity, each rental is treated as a separate activity. Under the material participation rules, the time of both spouses is counted.[8] The material participation test[9] then applies separately to each individual rental real estate activity. If the taxpayer materially participates in an activity, net income or loss from that activity is non-passive. If the taxpayer does not materially participate, despite being a real estate professional, the rental is passive and losses (or income) go on Form 8582.
A taxpayer, who does most of the work in a rental, meets Test 2 for material participation in Reg. § 1.469-5T(a)(2). However, if there is on-site management, it may be difficult for the taxpayer to materially participate because:
Request and closely examine the taxpayer’s documentation of time utilized for material participationin each activity. See the log-Chapter 5.
§ 1.469-9(g): Election available to group all rental real estate as one activity. Must be a written statement filed on an original return.
Activities meeting one of the six exceptions are treated as businesses. A taxpayer must then materially participate in order to treat the gain/loss as non-passive.
If no written lease, determine if a true rental arrangement exists.
Ask the taxpayer to explain what services, if any, the taxpayer provides with the equipment.
Request a copy of the management agreement or charter contract.
Determine the average period of customer use. If the rental activity falls under one of the six exceptions, request a detailed list of hours and services performed by the taxpayer.
Request a statement from the taxpayer as to whether any activities have been grouped.
§ 1.469-1T(e)(3)(ii)(A)-(F): Six exceptions to the definition of rental. If an exception applies, the rental activity is treated as a business and the material participation rules apply.
§ 1.469-1(e)(3)(iii): Each period during which a customer has a continuous or recurring right to use the property is a separate period. For example, if the property is used only a few hours at a time, but the lessee has a recurring right to use the property all year, the period of customer use is a year.
§ 1.469-4(d)(1)(i): General Rule: Rentals may not be grouped with businesses.
Owned in the exact same percentage and rented back to that business activity.
Many condos, vacation cottages, time-shares, hotels, motels, and bed and breakfasts have an average rental period of seven days or less. As a result, these activities are not defined as rentals[12], but instead are treated as businesses. Net losses from these activities are passive unless the taxpayer materially participates. Because many of these activities have a management company and may not be near to the taxpayer’s residence, materially participating[13] may be difficult. See checksheet at end of chapter.
Activities with an average rental period of 7 days or less are defined as businesses, not rentals. Therefore, the active participation standard and the $25,000 rental real estate allowance do not apply to these types of activities. Losses, if passive, go on Form 8582 line 3b, not 1b.
Inquire about personal use, including family membersor those renting at less than fair rental value.
Losses from businesses should be entered lines 3b, not 1b.
100 hours and more than anyone else[15]: The taxpayer must not only prove he worked more than 100 hours,but more than anyone else. He must be ready to provide evidence of the participation of others. Additionally, there is no provision in IRC § 469 to divide employee time by each unit.
Facts and circumstances[17]: This test cannot be used if anyone besides the taxpayer is paid to manage the activity. An on-site management agency disqualifies the taxpayer from using this test.
Many vacation rentals fall outside the rental definition[20]and are treated as businesses. If there is on-site management, it may be difficult for the taxpayer to meet the material participation standard.
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