One of our accountants asked me recently:
R: Do you think [so and so] qualifies as a
real estate professional?
CTG: I do not know [so and so]. Tell me a little.
R: Husband
pulls a W-2.
CTG: How much and
how many hours?
R: Blah blah
dollars.
CTG: Works in real
estate?
R: Nah.
CTG: Hours?
R: Maybe
2,000.
CTG: Is the wife
in real estate?
R: No.
I have told you (almost) everything you need to answer
the question.
Let’s look at the Warren case.
James Warren organized Warren Assisted Living, LLC in
2015.
He purchased a group home in 2016.
He started repairing the home almost immediately.
In 2017 he worked at Lockheed Martin for 1,913 hours
as an engineer.
On his 2017 tax return he claimed a $41 thousand-plus
loss from the group home. He claimed he was a real estate professional.
Warren did not keep time logs.
What sets this up are the passive activity rules under
Section 469. As initially passed, that Section considered rental activities
(with minimal exceptions) to be “per se” passive.
The passive activity rules would then stifle your ability to claim losses. You – for the most part – had to wait until you had income from the activity. You could then use the losses against the income.
Well, that caught real estate landlords and others around the country by surprise. When you do one thing, it is difficult to have a Congressional staffer decide that your thing is not a regular thing like the next thing across the street.
Congress made a change.
(c)(7)
Special rules for taxpayers in real property
business.
(A)
In general. If this paragraph
applies to any taxpayer for a taxable year-
(i) paragraph
(2) shall not apply to any rental real estate activity of such taxpayer for
such taxable year, and
(ii) this
section shall be applied as if each interest of the taxpayer in rental real
estate were a separate activity.
Notwithstanding
clause (ii) , a taxpayer may elect to treat all interests in rental real estate
as one activity. Nothing in the preceding provisions of this subparagraph shall
be construed as affecting the determination of whether the taxpayer materially
participates with respect to any interest in a limited partnership as a limited
partner.
(B)
Taxpayers to whom paragraph
applies. This paragraph shall apply to a taxpayer for a taxable year if-
(i) more
than one-half of the personal services performed in trades or businesses by the
taxpayer during such taxable year are performed in real property trades or
businesses in which the taxpayer materially participates, and
(ii) such
taxpayer performs more than 750 hours of services during the taxable year in
real property trades or businesses in which the taxpayer materially
participates.
In the case
of a joint return, the requirements of the preceding sentence are satisfied if
and only if either spouse separately satisfies such requirements. For purposes
of the preceding sentence, activities in which a spouse materially participates
shall be determined under subsection (h) .
The above is called the real estate professional exception. It is a mercy release from the per se rule that would otherwise inaccurately (and unfairly) consider people who work in real estate all day to not be working at all.
It has two main parts:
(1) You
have to spend at least 750 hours working in real estate, and
(2) You have to spend more than 50% of your
“working at something” total hours actually “working in real estate.”
If you are a real estate professional, you avoid the
“per se” label. You have not yet escaped the passive activity rules – you still
have to show that you worked - but at least you have the opportunity to present
your case.
The Court looked at Warren’s 1,913 hours at Lockheed.
That means he would need 3,827 total hours for real estate to be more than ½ of
his total work hours. (1,913 times 2 plus 1).
First of all, 3,827 total hours means he was working
at least 74 hours a week, every week, without fail, for the entire year.
Maybe. Doubt it.
Warren is going to need really good records to prove
it.
Here is the Court:
Mr Warren did not keep contemporaneous logs of his time renovating the group home.”
Not good, but not necessarily fatal. I represented a
client who kept Outlook and other records. She created her log after the fact
but from records which themselves were contemporaneous. Mind you, we had to go
to Appeals, but she won.
In preparation for trial, Mr Warren created – and presented – two time logs.”
Good grief.
The first log maintained that he worked 1,421 hours at the group home; it was created one week before trial.”
End it. That is less than his 1,913 hours at Lockheed.
The second log maintained that Mr. Warren worked 1,628 at the group home; it was created the night before trial.”
Why bother?
This was a slam dunk for the Court. They did not have
to dwell on contemporaneous or competing logs or believability or whether the
Bengals will turn their season around. Whether 1,421 or 1,628, he could not get
to more-than-50%.
Warren lost.
As a rule of thumb, if you have a full-time W-2, it
will be almost impossible to qualify as a real estate professional. The
exception is when your full-time W-2 is in real estate, maybe with an employer
such as CBRE or Cushman & Wakefield. At 1,900-plus Lockheed hours, I have no idea
what Warren was thinking, although I see that it was a per se case. That means
he represented himself, and it shows.
I suppose one could have a W-2 and work crazy hours
and meet the more-than-50% requirement, but your records should be much
tighter. And skip the night before thing.
BTW another way to meet this test is by being married.
Look at (B)(ii) again:
In the case of a joint return, the
requirements of the preceding sentence are satisfied if and only if either
spouse separately satisfies such requirements. For purposes of the preceding
sentence, activities in which a spouse materially participates shall be
determined under subsection (h) .
If your spouse can meet
the test (both parts), then you will qualify by riding on the shoulders of your
spouse.
Our case this time was Warren v Commissioner,
T.C. Summary Opinion 2024-20.
