Taxpayer Met Requisite Hours to be a Real Estate Professional; Passive Loss Rules Not Applicable

(Parker Tax Publishing June 2016)

The Tax Court held that the hours a part-time ski instructor spent in connection with her real estate activities met the requirements under Code Sec. 469 in order qualify her as a real estate professional. Because the IRS failed to timely challenge the character of the hours, and conceded the issue of her material participation in the rental activities, the court determined the passive activity loss limitations did not apply. Moon v. Comm'r, T.C. Summary 2016-23.

Background

During 2010 and 2011, the years at issue, Darsey Moon was a part-time ski instructor and her husband, Joseph Moon, was a full-time airline pilot for United Parcel Service, Inc. Darsey worked as a ski instructor for 90.75 hours during 2010, and 96.25 hours during 2011.

The Moons owned three rental properties during the years at issue. Darsey personally oversaw all rental activities and management of the rental properties, receiving occasional assistance from Joseph. In addition to managing the rental properties, she participated extensively in repairs to and renovation of the rental properties. She maintained logs of the time that she spent on the rental properties, and when the IRS examined the couples' returns, she summarized these logs into activity summaries. Darsey's activity summaries show that she performed services with respect to her rental real estate activities for 834.5 hours in 2010, and 863.5 hours in 2011.

On audit, the IRS determined that the claimed loss deductions for the years at issue with respect to the Moons' real estate activities were subject to the passive activity loss limitations under Code Sec. 469. The IRS also disallowed the couple's depreciation deductions for a GMC truck. In addition, the IRS determined accuracy-related penalties under Code Sec. 6662(a).

Analysis

Under Code Sec. 469, taxpayers are generally precluded from deducting passive activity losses, including rental activity, which is usually treated as a passive activity. Code Sec. 469(c)(7) provides an exception where the taxpayer is a real estate professional. Under Code Sec. 469(c)(7)(B), a taxpayer qualifies as a real estate professional if: (1) more than one-half of the personal services performed in trades or businesses by the taxpayer during the tax year are performed in real property trades or businesses in which the taxpayer materially participates, and (2) the taxpayer performs more than 750 hours of service during the tax year in real property trades or businesses in which the taxpayer materially participates.

In its pretrial memorandum, the IRS asserted that the hours Darsey spent on business and tax issues in 2010 and 2011 were investor hours and should be excluded from the number of hours that she spent in real property trades or businesses for purposes of determining whether the activities were passive. The Tax Court noted that the IRS did not present argument on those points in its brief for trial, and concluded that the IRS abandoned those issues. In addition, because the IRS did not assert that Darsey failed to materially participate in any other of her real property trades or businesses during any of the years at issue, the court treated the omission as a concession that she materially participated in those activities.

The IRS also argued that Darcey's activity summaries were not reliable because the logs that they were based on were not prepared contemporaneously, and that she overstated the time that she spent on the real estate activities in the logs. The court disagreed, stating that on the basis of its review of the logs and Darcey's credible testimony, the logs were prepared contemporaneously and the time in the logs was not overstated.

The court observed that Darsey's activity summaries indicated that she performed more than 750 hours of personal services for her real estate activities in 2010 and 2011. In addition, the court noted that because Darsey worked less than 200 hours each year as a ski instructor, more than one-half of her personal services were in real property trades or businesses in which she materially participated. Accordingly, the court determined that she met the requirements of Code Sec. 469(c)(7)(B) to qualify as a real estate professional, and that her rental activities were therefore not passive activities subject to the passive loss limitations.

With regard to the depreciation deductions, the court noted that the Moons did not provide a mileage log for the GMC truck, and conclude that the couple failed to substantiate the expenses relating to the truck. The court also upheld the accuracy-related penalties under Code Sec. 6662(a), noting that the underpayments of tax required to be shown on the Moons' returns for the 2010 and 2011 tax years were attributable to negligence for their failure to keep adequate books and records or to substantiate their items properly.

For a discussion of the deductibility of rental losses, see Parker Tax ¶247,105.

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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