What to Do When the IRS Says They Want to Audit Your Real Estate Losses


A few years ago, the IRS started aggressively auditing tax returns that had real estate losses. In the beginning, the IRS audit teams (yes, teams) were disallowing hours, questioning losses and basically, making the taxpayer’s audits go pretty rough.

The audits have gotten a little easier because we’ve nailed down what they are looking for and the IRS has lost some key Tax Court cases in this regard.

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Here are the issues in a nutshell.

  • Most of the losses are focused on real estate operating losses. In other words, you’re claiming a tax loss while you hold property.
  • If you make less than $100,000 per year, you can take $25,000 of real estate losses against your other income. You’ll need to prove active participation (100 hours) and, of course, prove that the deductions are legitimate and that you’ve reported all rental income.
  • If you make more than $150,000 per year, you can’t take any real estate loss against your other income unless you file as a Real Estate Professional.

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If you are audited based on your Real Estate Professional status:

  • Be ready to prove that your real estate professional activities were ACTIVE. It isn’t time spent going to seminars or surfing the Internet. One of the past issues had been that a real estate agent couldn’t count her hours. The IRS lost that issue in Tax Court. (Thank goodness)
  • Be ready to prove that any other trade or business hours were less than the real estate hours.
  • Be ready to prove that you materially participated in each property to the tune of 500 hours per. Or, show the IRS where you made an election to aggregate the properties.
  • Be ready to show that the properties were not held in a Limited Partnership. NOTE: There was a case that the IRS lost that is somewhat related, although not completely, to this issue. In that case, it may indicate that a limited partner in a limited partnership can still take a real estate loss against other income if all other requirements are meant.

This is just a quick overview. If you get a notice that you’re being audited, get all the help you can. We have a copy of the audit handbook, along with arguments you can use if you’re audited in the Real Estate Professional Audit Survival Package.


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6 Comments so far:


On April 1st, 2010 | 10:51 am
Margaret Iverson said:

I’m confused - in the Advanced Real Estate Forum your February 21st Forum Post titled “Tricks and Traps of Real Estate Professional Status” you said:

“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.”

Now here in your blog post you say time spent going to seminars and internet time IS active:

“Be ready to prove that your real estate professional activities were ACTIVE. It was time spent going to seminars or surfing the Internet.”

Can you clarify this discrepancy?


On April 2nd, 2010 | 2:52 pm
Diane Kennedy said:

I corrected the offending word in the above blog.


On August 13th, 2010 | 10:36 am
Stacy B said:

Would providing financial planning and tax advisory services specifically targeted to real estate investors qualify as a Real Estate Professional?


On August 20th, 2010 | 1:40 pm
Diane Kennedy said:

Stacy, under the tighter interpretation by the IRS, I’d say the answer is no. The work is not active specifically for real estate.


On February 9th, 2011 | 12:24 am
Real Estate Capital Gains and Capital Losses | USTaxAid Services said:

[...] What to Do When the IRS Says They Want to Audit Your Real Estate Losses [...]


On March 19th, 2011 | 12:25 am
Changes Coming to Reporting Real Estate Losses | USTaxAid Services said:

[...] What to Do When the IRS Says They Want to Audit Your Real Estate Losses [...]



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