I am looking at a case containing one of my favorite slams so far this year.
Granted, it is 2020 COVID, so the bar is lower than usual.
The case caught my attention as it begins with the following:
The Johnsons brought this suit seeking refunds of $373,316, $192,299, and $114,500 ….”
Why, yes, I would want a refund too.
What is steering this boat?
… the IRS determined that the Johnsons were liable for claimed Schedule E losses related to real estate and to Dr. Johnson’s business investments.”
Got it. The first side of Schedule E is for rental real estate, so I gather the doctor is landlording. The second side reports Schedules K-1 from passthroughs, so the doctor must be invested in a business or two.
There is a certain predictability that comes from reviewing tax cases over the years. We have rental real estate and a doctor.
COMMENT: Me guesses that we have a case involving real estate professional status. Why? Because you can claim losses without the passive activity restrictions if you are a real estate pro.
It is almost impossible to win a real estate professional case if you have a full-time gig outside of real estate. Why? Because the test involves a couple of hurdles:
· You have to spend at least 750 hours during the year in real estate activities, and
· Those hours have to be more than ½ of hours in all activities.
One might make that first one, but one is almost certain to fail the second test if one has a full-time non-real-estate gig. Here we have a doctor, so I am thinking ….
Wait. It is Mrs. Johnson who is claiming real estate professional status.
That might work. Her status would impute to him, being married and all.
What real estate do they own?
They have properties near Big Bear, California.
These were not rented out. Scratch those.
There was another one near Big Bear, but they used a property management company to help manage it. One year they used the property personally.
Problem: how much is there to do if you hired a property management company? You are unlikely to rack-up a lot of hours, assuming that you are even actively involved to begin with.
Then there were properties near Las Vegas, but those also had management companies. For some reason these properties had minimal paperwork trails.
Toss up these softballs and the IRS will likely grind you into the dirt. They will scrutinize your time logs for any and every. Guess what, they found some discrepancies. For example, Mrs. Johnson had counted over 80 hours studying for the real estate exam.
Can’t do that. Those hours might be real-estate related, but the they are not considered operational hours - getting your hands dirty in the garage, so to speak. That hurt. Toss out 80-something hours and …. well, let’s just say she failed the 750-hour test.
No real estate professional status for her.
So much for those losses.
Let’s flip to the second side of the Schedule E, the one where the doctor reported Schedules K-1.
There can be all kinds of tax issues on the second side. The IRS will probably want to see the K-1s. The IRS might next inquire whether you are actually working in the business or just an investor – the distinction means something if there are losses. If there are losses, the IRS might also want to review whether you have enough money tied-up – that is, “basis” - to claim the loss. If you have had losses over several years, they may want to see a calculation whether any of that “basis” remains to absorb the current year loss.
Let’s start easy, OK? Let’s see the K-1s.
The Johnson’s pointed to a 1000-plus page Freedom of Information request.
Here is the Court:
The Johnsons never provide specific citations to any information within this voluminous exhibit and instead invite the court to peruse it in its entirety to substantiate their arguments.”
Whoa there, guys! Just provide the K-1s. We are not here to make enemies.
Here is the Court:
It behooves litigants, particularly in a case with a record of this magnitude, to resist the temptation to treat judges as if they were pigs sniffing for truffles.”
That was a top-of-the-ropes body slam and one of the best lines of 2020.
The Johnsons lost across the board.
Is there a moral to this story?
Yes. Don’t be a jerk.
Our case this time was Johnson DC-Nevada, No 2:19-CV-674.