Many people decide to acquire rental property because they have extra time available to manage the endeavor. Even if they don’t earn a lot of money in the beginning, they hope to eventually profit. Meanwhile, they expect to deduct any losses from their other sources of income. When tax return preparation for these individuals become Enrolled Agent jobs, some are startled to discover the deduction limits imposed on passive activities.
All too frequently, a taxpayer will claim exemption from the passive activity limitations. When this happens during Enrolled Agent work, a sound procedure is delivering some facts to the taxpayer. In most cases, taxpayers do not meet the guidelines described in EA training about unlimited deduction of rental loss for real estate professionals. Reliance on time records is a crucial exercise. A person may believe they spent plenty of time managing rental property but fail to meet the time qualifications.
The recent Tax Court decision for a couple named Hudzik conveys the importance of maintaining time records. They deducted the losses on two rental properties because Mrs. Hudzik asserted that she was a real estate professional. The standards for this designation are clear from an Enrolled Agent course but the Hudziks did not obtain tax advice from an EA. A taxpayer qualifies as a real estate professional when two conditions are met. First, more than half of the taxpayer’s work during the year must comprise material participation in the real estate business. Secondly, the taxpayer must perform more than 750 hours of services as material participation in real estate activities.
Mrs. Hudzik had a job outside of the real estate industry in which she worked 1,650 hours per year. She also commuted daily 64 miles each direction between her residence and place of employment. These facts alone are sufficient to raise suspicions of an Enrolled Agent tax expert about qualification as a real estate professional. With only 168 hours in a week, Mrs. Hudzik only has about 125 left after considering her job and commute time. Only 50 hours per week remain after allowing 75 hours for sleeping, eating, and personal grooming. Yet, Mrs. Hudzik contended she spent an average of over 1,800 hours annually on real estate activities during a three year period.
She produced a log for each year reflecting time spent on the rental properties. However, the logs lack precise descriptions of services performed. Some of the entries fail to identify the amount of time allocated to each property.
The Tax Court rejected Mrs. Hudzik’s time logs as implausible by noting that she would have spent almost all of her spare time working on the rental properties. Of course, her regular job plus management of the real estate is not an impossible schedule. Quite a few people work 70 to 80 hours per week. Many individuals with Enrolled Agent careers can testify to this fact. However, that pace is generally not sustainable for three years. Some breaks usually become necessary. This issue doesn’t impact the Hudziks anyway because they failed to properly substantiate the hours claimed.
IRS Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.