Originally published on Forbes.com July 18th, 2013
So you want to be a real estate professional. That is the wish of just about everybody who loses money on their rental properties. Starting this year, thanks to the 3.8% Obamacare tax, it will become the wish of many who make money on their rental properties. Whether you qualify or not boils down to how you spend your time.
You need to spend 750 hours in a year on your real estate activities. That does not seem like too much of a hurdle. Much harder, for many, is the requirement that you spend half your time working on real estate activities.
If challenged, you better be able to prove how much time you spent, ideally with some sort of contemporaneous journal. Reading the cases makes me conclude that if you have a full-time day job, the IRS is not going to believe that you spent more time on your real estate than your day job and the Tax Court will probably back them up. The latest case is that of Garfield Windross.
The stakes were pretty high – deficiencies of $37,788 and $24,988 for 2007 and 2008 respectively. Mr. Windross, with his spouse, owned a two unit rental property and a four unit commercial property. He spent a lot of time on real estate:
During the years in issue petitioner researched rental properties, acquired the Los Angeles property, found financing for the rental properties, listed the properties for rent and showed them to potential clients, and wrote his own lease agreements. He did not hire a property manager. Petitioners were interested in starting a property management or investment business, and before purchasing the Los Angeles property they traveled several times from their home in Oakland to Los Angeles to research properties in the Los Angeles area. Before 2007 petitioner established Klade Properties, LLC (Klade), a property management company. In May 2008 petitioner converted Klade from an LLC to a corporation.
He had the advantage of working from home, but he, at least apparently, spent significant time on his day job working for Hewlett-Packard
Garfield K. Windross (petitioner) worked as a consultant at Hewlett-Packard (HP) in 2007 and 2008, the years in issue. HP permits certain employees to work from home, and petitioner worked from home during the years in issue. In 2007 HP paid petitioner $123,067 in wages, and he used 40 hours of vacation time. In 2008 HP paid petitioner $107,008 in wages, and he used 208 hours of vacation time. Petitioner was paid as a full-time employee, and during the years in issue, he was paid bimonthly for 87 hours of work per pay period.
That would set the bar for his required real estate hours pretty high. Mr. Windross argued that it should be lowered some, but the Tax Court did not buy it.
Petitioner asserted that the HP payroll records were an inaccurate reflection of the amount of work he actually performed for HP. Despite his contention, petitioner provided nothing beyond his vague testimony that “during my year I’m actually less than 50 percent utilized ”, to refute the hours in the HP payroll records.
The Tax Court was also not impressed with his time records.
Petitioner maintained a calendar that reflects some of the work he completed related to the rental properties, such as installing flooring, tiling, landscaping, repairs, and inspecting the properties. He normally recorded his rental property activities on the calendar at the time he did the work, but he did not record all of the activities on his calendar because some of the activities were ongoing. At some point after each year in issue, in response to an IRS audit, petitioner created logs, one for each year in issue, reflecting the amount of time he purportedly spent on the rental real estate activities. Petitioner created the logs from memory and the information on his calendar.
When you see that word “purportedly” in a decision, you can be pretty sure it is not going to go well for the taxpayer.
Petitioner admitted that some of the hours listed in the logs were ballpark estimates.
Here is another tip if you are arguing about time records in a passive activity case. Never, ever say the word “ballpark”.
Petitioner did not provide any underlying documentary evidence to substantiate all of the hours spent on the rental real estate activities that are reflected in the logs or on his calendar. Though it is clear from the record that petitioner did spend some time on the rental activity, he has not established, and we are not persuaded, that more than one-half of his personal services were performed in real property trades or businesses in the years at issue.
I think it is close to hopeless for someone with a full-time day job to win one of these cases. If you are going to try to do it anyway, keep a detailed log of your real estate activities, contemporaneously. Cross-reference the log to documents such as invoices, phone bills and print-outs of e-mails. Have a nice fat three-ring binder to hand to the agent when the question comes up. Even though the IRS seems pre-disposed to not believe anybody with a full-time day job can qualify, they also don’t like to lose cases.
You can follow me on twitter @peterreillycpa.