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.
- 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.
- 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.