Dentist Qualifies as Real Estate Professional; Rental Real Estate Losses Are Deductible

(Parker Tax Publishing March 2017)

The Tax Court held that a dentist's logs of real estate activities, as well as testimony from various witnesses, established that he spent the requisite amount of time on real estate activities to qualify as a real estate professional. Accordingly, he was entitled to deduct his rental real estate losses against the income from his and his wife's dental practice. Zarrinnegar, T.C. Memo. 2017-34 (2/13/17).

Background

Mohammad Zarrinnegar and his wife, Mary, owned and operated two businesses during 2010, 2011, and 2012: a dental practice and a real estate business. They are both dentists and, during the years at issue, worked at their joint dental practice in shifts. Mary worked Mondays, Wednesdays, Thursdays, and Fridays from 9 a.m. until 2:30 p.m. and some Saturdays from 8 a.m. until 12 p.m. Mohammad worked at the dental practice Mondays, Wednesdays, Thursdays, and Fridays from 2:30 p.m. until 6 p.m.

The couple's real estate business consisted of Mohammad's real estate brokerage activity and four rental properties that the couple owned and that Mohammad managed. Mary did not participate in the real estate business.

Mohammad spent hundreds of hours on brokerage-related activities, including brokers' tours, listing searches, open houses, property viewings, and client meetings. He also spent significant time each year managing the couple's four rental properties. All told, Mohammad spent over 1,000 hours on the real estate business during each year at issue.

The dental business showed a net profit of approximately $468,000, $322,000, and $381,000 for 2010, 2011, and 2012, respectively. These amounts were reported on the couple's tax returns for those years along with losses from the real estate business of $222,000 for 2010; $242,000 for 2011, and $221,000 for 2012. The IRS disallowed the losses because it determined that they were passive activity losses. The couple disagreed and took their case to the Tax Court.

Analysis

As a general rule, Code Sec. 469(c)(2) provides that rental activities are per se passive whether or not the taxpayer materially participates. Thus, losses from such activities are passive losses that are deductible only against passive income. As an exception, however, rental activities of taxpayers in real property trades or businesses (i.e., a real estate professionals) are not treated as passive if the material participation requirement under Code Sec. 469(c)(7) is satisfied. Under that provision, a taxpayer is a real estate professional if:

(1) more than one-half of the personal services performed in trades or businesses by the taxpayer during such tax year are performed in real property trades or businesses in which the taxpayer materially participates; and

(2) such taxpayer performs more than 750 hours of services during the tax year in real property trades or businesses in which the taxpayer materially participates.

Before the Tax Court, the couple offered Mohammad's testimony and logs of hours for 2010, 2011, and 2012. Mohammad testified at great length about the logs' contents and was able to recall extensive details relating to the entries. Each log showed that Mohammad spent more than 1,000 hours per year on real estate activities. Mary also testified, as well as several other witnesses.

The court found that all the testimony offered in the case was credible and that it corroborated Mohammad's logs and testimony. Accordingly, the court concluded that Mohammad worked more than 1,000 hours per year at the real estate business and worked fewer than 1,000 hours per year at the dental practice, satisfying both elements of the real estate professional test. Thus, the taxpayers had met material participation requirement under Code Sec. 469(c)(7) and were entitled to deduct the rental real estate losses incurred during the years at issue.

For a discussion of the deductibility of rental real estate losses by real estate professionals, see Parker Tax ¶247,120.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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