Time that a taxpayer considered himself “on call” for his real estate business could not be counted toward hours in which he performed services for it, limiting the losses he could claim, the Tax Court held.
James Moss and his wife owned seven rental real estate properties in 2007 that they treated as a single activity. On their 2007 tax return they deducted a loss of $40,490 from this activity, of which the IRS disallowed $31,318. In the Tax Court, Moss argued that he was entitled to the full loss because he was a real estate professional.
In 2007 Moss was employed at a nuclear power plant as a nuclear technician. For that year, he clocked 1,900 hours at this job, including 200 to 300 hours of unscheduled overtime. Although he did not keep a detailed contemporaneous log, he estimated that he spent 137.75 hours traveling to and from the rental properties and 507.75 hours working on the rental properties, for a total of 645.5 hours. He also claimed that he was on call to work at the rental properties while not at the power plant and that these on-call hours should count as hours in which he was performing services in the real estate business.
Rental property is presumed to be a passive activity. Section 469(c)(7) eliminates this presumption if the taxpayer is a real estate professional. Section 469(i) allows individuals who are not real estate professionals but are active participants in a real estate activity to deduct up to $25,000 of loss, reduced if the taxpayer’s adjusted gross income (AGI), without regard to the passive loss, exceeds $100,000.
To be a real estate professional, taxpayers must meet two tests: They must work for more than 750 hours during the tax year in the real estate business, and they must devote more than half of their work hours to the real estate business. If Moss had been allowed to count at least 55 hours of the time he considered himself to be on call for his real estate business as applying toward the total, he might have met the first test. The Tax Court noted, however, that IRC § 469(c)(7)(B) defines the 750-hour and one-half of all time spent performing personal services requirements as those in which the taxpayer performs services in a trade or business in which the taxpayer materially participates and that, for the time Moss considered himself on call, he was not performing such services.
To prove that they meet these tests, taxpayers must maintain reasonable records. A post-event ballpark “guesstimate” is not acceptable. Although the court did not address Moss’ substantiation of his work hours, it noted that the 645 hours he said he worked on his properties was an estimate. It did not count any hours for his on-call status. Consequently, Moss did not meet the first requirement to be considered a real estate professional. The court did not consider the second test, but if it had, he would have failed it as well, based on the reported work hours.
Moss did qualify as an active participant in real estate and was initially entitled to deduct $25,000 of his loss. However, that amount had to be reduced by his AGI over $100,000, not including the passive loss. The result for Moss was an AGI in 2007 of $131,656, which reduced the deductible loss to $9,172.
The IRS also imposed penalties under section 6662(a) for negligence. Moss argued that he relied on a CPA to prepare his return and therefore was not negligent. Since he did not provide his CPA with the hours worked on the properties, he could not rely on the fact that a CPA prepared his return. To be exempt from penalty based on reliance on a professional, taxpayers must provide all necessary and relevant information to the professional.
James F. Moss v. Commissioner , 135 TC no. 18
By Edward J. Schnee, CPA, Ph.D., Hugh Culverhouse Professor of Accounting and director, MTA Program, Culverhouse School of Accounting, University of Alabama, Tuscaloosa.
More from the JofA: