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IRS Challenges to the Real Estate Professional Status

The IRS has been stepping up their audits of anyone who takes a real estate loss on their tax returns. Some of their arguments against the taxpayers are valid and a lot of them are not.

Here are some of the recent challenges to the real estate professional status by the IRS and what you can do about it.

IRS Argument:  A real estate agent is not a real estate professional

One of the allowed real estate professional activities is “brokering  a deal.”  In some cases, the IRS has taken the position that a real estate agent doesn’t qualify because he or she is a not a broker. There have been at least three Tax Court rulings against the IRS when they have taken that position.

Bottom Line:  Real estate agent hours do count as real estate professional hours.

IRS Argument:  Material participation is 750 hours, not 500 hours

In earlier articles in this series, we talked about the need for material participation in order to claim the real estate professional deduction.  The amount needed is 500 hours per property, unless you aggregate properties in which case it is 500 hours total.

However, the IRS Audit Technique Guide (ATG) for real estate professionals has a mistake. In one place it says that the material participation is 750 hours. In another place, it correctly states that it is 500 hours.

Bottom Line: This mistake can mislead auditors, but it is wrong.

IRS Argument:  A limited partner in a limited partnership automatically does not qualify as a real estate professional

I need help with the IRS

The IRS seems to be rewriting the rules...

The IRS issued Proposed Regulations for Code Section 469 in December 2011. These clearly explain the situations under which a limited partner CAN have material participation.

Unfortunately, the IRS didn’t update their ATGs that they give auditors. The auditors are still trained to immediately deny any limited partners the benefit of real estate professionals.

There are also some IRS positions that aren’t clearly valid or invalid. For example, if you use a property manager, the IRS will likely deny that you are actively participating.

They began a massive audit offensive in June 2012, targeting most property managers in Arizona. During the audit, they are compiling lists of their real estate investor clients. At this point, we’re not certain exactly what they will be doing, but a best guess is that they will select these investors for audit.

Rewriting the Rules?

The IRS is checking on anyone who has received a Form 1099-A showing a foreclosure or deed-in-lieu-of foreclosure  If the property is in a state which is considered non-recourse, then the lender cannot pursue additional claims against the borrower. At that point, normally the lender will calculate how much the debt forgiveness is and issue a Form 1099-C.

Now the IRS says that as soon as you have a Form 1099-A, you have debt forgiveness income if you’re in a state where loans are non-recourse.

Although this last one doesn’t have anything to do with the real estate professional status, it demonstrates how the IRS is rewriting the rules or at the very least, sending out inexperienced auditors with incomplete and sometimes inaccurate handbooks.

It’s never been more important to make sure you have an experienced tax strategist and tax preparer helping you. It’s not enough to hire someone with some tax experience. If you have real estate, you need someone with real estate tax experience.

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About the Author...

Diane Kennedy, CPA helps real estate owners legally pay less tax. She’s the New York Times best-selling author of “Loopholes of the Rich”, “Real Estate Loopholes”, and 7 other best-selling financial and tax books. She’s also a business owner and real estate investor. Her motto is “It’s Your Money. Keep More of It.”

Learn more about Diane by visiting USTaxAid

Comments

  1. B Nashiko says:

    Helpful

  2. Kate Smith says:

    IRS has bizarre interpretations as always: “brokering a deal” is an activity performed by ANY licensed real estate professional being Broker or Agent!!! Unless, there is an activity called otherwise that is pertinent to agents, which I am not aware of: maybe agenting a deal (Thesaurus disagrees though).

    The CORE of our business is to “BROKER” deals!

  3. Sandy Lutterbie says:

    Two years ago I completed a 4-yr audit which encompassed 2.5 years. The auditor was embroiled in office politics with his new supervisor. She then ordered every agent to look for unreported income. What began as a simple request for 10 HUD-1’s became a nightmare. After several meetings with agent, supervisor, CPA and me, it was apparent the IRS had read none of the many documents (including sources of bank deposits, daily logs, leases, etc) and they were not too familiar with Code 469 (c).. Finally, the next step was Appeals but first I wanted to make my case one more time…on my terms, totally shocking our CPA who said he had NEVER had a client who wanted to meet with IRS once, let alone on several occasions. My husband and I prepared a power point presentation and took control of the meeting in the first 15 seconds, as WE had called the meeting. Low and behold…in less than two hours we were done and WE WON!!! This was worth a chunk of $$$…totally worth the time invested. Of all the people I have told this story to, everyone has said early on, just let your CPA do it all. In the final meeting, it was I who realized the IRS had it fixated in their head that I had ten rental properties in vacation destinations where renters changed weekly and therefor others did 99% of the work, as opposed to my actual rentals that had tenants who stayed 12+months and I was the Property Manger. Also,. fortunately I had found the Audit Guide early on and new where their questions were going. A time consuming and emotionally draining nightmare that I would not wish on my worst enemy.

  4. I have 9 vacation properties I rent out. 3 do not meet the long term requirement of above 7 day average rental. An audtor is stating I can claim them toward the 750 hours since I aggregated as one. However, is saying the time spent on them counts toward w2 hours instead of Realestate Professional hours in calculating the > than 50% rule.
    This means their time is being counted against the hours added for >50%. That seems incorrect to me, since they are part of a realestate activity of managing or operating realestate?

    If anyone has clarification, would be appreciated.

  5. james says:

    Great Article. Thanks for the info. Does anyone know where I can find a blank “2012 IRS 1099-A” to fill out?

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