Sunday, January 22, 2012

The ‘Split the Difference’ Case
Taxpayer was an established landlord who owned 6 actively rented properties. In one year he acquired 3 additional properties to rent but wound up selling them before the year was out without ever renting them. He wound up at odds with the IRS because he claimed to be real estate professional eligible to deduct passive losses against ordinary income and because the IRS asserted that the gain on the sale of the 3 never-rented properties was a capital gain not eligible to be netted against passive losses from the operation of the rented properties.

Take aways:

• Taxpayer had an unrelated full-time job which always makes it difficult to prove RE professional status since one of the points to prove is that you spent the majority of your business-related time on the rental business. For those who are rusty at math, this means if you work 2000 hours a year at something else, you need to prove 2001 hours spent on being a landlord.

• The court noted that to carry the burden of proof re: the above point “requires more than a post-event ballpark guesstimate of time committed to participation in a rental activity” and that “his subjective estimate suffers from a lack of contemporaneous verification by records or other evidence.” Really? You show up at tax court empty-handed?

• The Court ruled against the IRS deeming the purchase/sale of the 3 never-rented properties part of the same passive real estate activity as the rental properties thereby allowing the taxpayer to net the proceeds from the sales against the rental losses. TP was able to successfully convince the court that his primary intent when he acquired these properties was to rehab and rent them.

• It is interesting that the IRS tried to characterize these transactions as capital. One wonders whether they would have taken this approach had the properties been held for longer than 1 year prior to the sale, thus making the gains eligible for taxation at a reduced rate.

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