Taxing Lessons From Court Decisions

Decisions — Time

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3 minute read
Image source: free picture, Pocket Watch IVID: 31716 ©Winterberg, Dreamstime Stock Photos
Image source: free picture, Pocket Watch IVID: 31716 ©Winterberg, Dreamstime Stock Photos

Since this Saturday is the longest day of the year in the northern hemisphere, it seemed appropriate that time played a role in three of this week’s tax court decisions.

Two of the cases involved the “real estate professional” exception to the passive activity rules.

When you’re considered a real estate professional, your rental real estate activities are not automatically deemed passive but instead are treated as trades or businesses.

You qualify for this exception if you meet the “material participation” requirements of internal revenue code section Sec. 469(c)(7)(B), which consists of two parts.

First, more than one-half of the personal services performed in trades or businesses are performed in real property trades or businesses in which you materially participate, and

Second, you perform more than 750 hours of services during the taxable year in real property trades or businesses in which you materially participate.

In T.C. Summary Opinion 2014-54 (Alfaro), the taxpayer worked full time at a factory. His time at work during 2010 (the year at issue) totaled 1,680 hours, averaging 35 hours per week, for a total of 48 weeks, with 2 weeks of vacation, 1 week of sick leave, and 1 week during which the factory was closed.

He also owned two rentals, for which he performed services relating to management, such as rent collection, maintenance, and repairs. He kept a calendar book with handwritten notes of the time spent performing the services. The book showed a total of 256 hours for 2010, and the taxpayer testified that he spent more time working at the properties than was reflected in the book.

The taxpayer claimed a $44,266 loss on the rental properties on his 2010 return. The IRS said the loss was not deductible under the passive activity rules.

The question at issue: Did the taxpayer qualify for the “real estate professional” exception to the passive activity rules? The court said he did not.
[WATU 2]

Taxing Lesson: All we have to do is decide what to do with the time we have.

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As reflected in our findings, the taxpayer worked 1,680 hours at the factory where he was employed during 2010. Therefore, to establish that he qualifies for the exception provided in section 469(c)(7), he must show he performed more than 1,680 hours of services (that is, more time than he worked at the factory) in real property trades or businesses in which he materially participated during 2010.

He testified he spent more time working at the properties than was recorded in the calendar book, but the testimony is simply too vague to support a finding that he spent approximately 1,400 hours more–as would be required to show that his time working at the properties exceeded his time working at his factory job.

In order for the taxpayer to have approximated 1,400 hours of rental-property-related work following this schedule in 2010, it would have been necessary for him to work at the rental properties three hours every weekday after work and 14 hours every weekend.

On this record, we are not persuaded that he did so. Because the evidence falls considerably short of demonstrating that he spent more than 1,680 hours during 2010 performing services with respect to the rental properties, he does not qualify for the section 469(c)(7)(B) exception and his rental real estate activities are deemed to be passive activities under section 469(c)(2).

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