Tricks and Traps of Real Estate Professional Status

[Diane Kennedy]

The IRS is just pounding real estate professionals in audit these days.

Some of the things to watch out for if you get called into audit:

- Make sure you have plenty of real estate activity hours. And 'activity' means active. It doesn't mean sitting in a seminar learning about real estate or surfing the Internet. That's one of the things that the IRS is going to be looking for - hours that aren't really meeting the criteria of activities. You will need to have more hours in real estate activities then in any other trade or profession. So this could mean that you have to prove how many hours you have in the other trade.

- Just having a real estate license doesn't prove hours. You must have hours logged, proving that you are active.

- You must be active in the real estate business. Unfortunately, some people claimed REP status when they never bought a property - all they did was look and go to seminars. They aren't active until they buy.

- There must be material participation in the properties. That means you are active in the properties in addition to the REP activities. And that means 500 hours per property unless you have taken an election to aggregate.

- You could be in trouble if you hold your property in a Limited Partnership. A surprising Tax Court ruling, though, seems to indicate that LP interest can still be active. (Surprises me - I expect to see more rulings going the other way on this)

Don't go into an audit unprepared. Don't volunteer information. Have lots of neat and orderly documentation. Show more hours than the minimum. Bring pictures, diagrams and other proof that you really were active.

[reslcg]

Why is it 500 hours for each property? By the definition of "material participation," why wouldn't it be only 100 hours for each "activity" (or property in my case) provided that there are at least 500 hours overall towards Real Estate Professional activities?

Definition of Material Participation (from http://www.irs.gov/publications/p925/ar ... 1000104579 )

A trade or business activity is not a passive activity if you materially participated in the activity.

Material participation tests.

You materially participated in a trade or business activity for a tax year if you satisfy any of the following tests.

- You participated in the activity for more than 500 hours.

- Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who did not own any interest in the activity.

- You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who did not own any interest in the activity) for the year.

- The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you did not materially participate under any of the material participation tests, other than this test. See Significant Participation Passive Activities, under Recharacterization of Passive Income, later.

- You materially participated in the activity for any 5 (whether or not consecutive) of the 10 immediately preceding tax years.

Thanks for any help!!!

[ryanmilan]

great reply R, id like to know this as well.

thanks!

Ryan

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[nonniemaria]

Confused by this also--I am in appeals over this --over a 7 day or less rental which my tax preparer showed as a rental loss--which based on my research seems it was reported incorrectly--it seems that although there are multiple ways to prove material participation the IRS wants to only see the 500 hours and when I showed them that they disputed many of them==for example my daily check in of the owner vacation rental web site I use. The appeals examiner was so arrogant and refused to give his managers name so my representative filed a complaint the next day and had it assigned to someone else. By the end of the next day they made an offer to settle for 20% of the total which I am inclined to do except--as continuing to fight this will cost more than the settlement--except I now fear being audited in subsequent years. I now keep a contemporaneous log on an i phone app and although my tax preparer says each year stands on its own I found a case that Judge Kroupa decided in 2005 where she allowed a taxpayer to recreate her narratives because she was currently doing the same activities as in prior years--so he presented those in the appeal.
Why when there are several ways to prove material participation does the taxpayer have to do 500 hours. I am a realtor, have no management company and do all advertising, write and have all contacts with tenants etc--yet they want to question that I materially participate.

[papreca]

500 hours? quite demanding.
"Don't go into an audit unprepared"
What if I'm already called and I don't have the proof for the 500 hours? Should I bring my lawyer with me.

[jeevanswaraaj]

I think a lot of Realtors who were successful at one time are no longer as successful. If you don't change with the market and use the latest and most innovative tools and marketing, you are not going to make it. If you are willing to work really hard and get out there and meet people, market yourself, be different, and innovate you can make it.

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[mswoods]

All very good points. I do agree with a few of few of the comments that 500 hours seems a bit much. But your essential point about being able to prove material involvement is valid. Taking continuing ed and attending a few seminars won't cut it.

[dantop]

Its certainly important to be an active agent. No offense to seasoned professionals here but it seems everyone is a part time agent these days. I work with home owners and many ask this question, so I guess its important to face the facts and if you're part time make sure you're doing something to become full time.

Dan
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