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Tax Court Rejected Taxpayer’s Deduction of Passive Losses on Real Estate Properties

Being a Real Estate Professional

The Tax Court rejected a taxpayer’s claim that he was a real estate professional. The taxpayer owned 7 properties. He additionally owned two other businesses.

One was a mortgage application processor, the other business sold health drinks. His real estate endeavor lost money year by year. As part of his tax strategy, he would take the losses on his personal tax return to reduce his overall tax liability. The IRS reviewed his tax return and took the position that this passive loss should not be allowed on his tax return.

The taxpayer took the time to catalog all of his time spent dealing with the properties.  In total for the year in dispute, he performed more than half time services and above 750 hours (or so he claimed) on the properties as required.

The Tax Court viewed the evidence and arguments and ruled against the taxpayer.  What was particularly damaging was that a management company was managing the properties for him. In the eyes of the Court, this, combined with the fact he was processing mortgage applications full time, would have made it impossible to fulfil the time requirements (at least half time/750 hour) for any given year.  Therefore, no passive expense deductions were allowed.

Editor’s Comment 

A lot of people are tempted to take a passive loss deduction when it is simply not appropriate. If you take this deduction you must be able to substantiate your position with the IRS. If you do not substantiate your position, you’re open game for the IRS and they will not hesitate to remove the deductions. This brings an unexpected tax liability to you, the taxpayer at often some of the most inopportune moments in your cash flow. Also, it gives the IRS another in road to review more tax returns creating a snowball effect. Bottom line, either substantiate your position or be prepared for a potential large outlay of cash.

By: Basi & Basi at the Center for Financial, Legal and Tax Planning for Transworld M&A Advisors