Can I rely upon my tax preparer to avoid IRS penalties?

[Bruce D. Kowal]

IRS is not shy about disputing claims to Real Estate Professional status.  It's an easy desk audit for IRS.  They query Schedule E losses.  And if IRS challenges your claim to be a Real Estate Professional they will slap on a 20% negligence penalty. §6662(a) and (b)(2).  

So, can you at least blame the tax preparer?  You know, tell IRS that you relied upon the advice of a professional?  Possibly.  You have to demonstrate that you acted with reasonable cause and in good faith.

OK. So what are the requirements?

1]  You must show that the Adviser [the person who prepared your return] had sufficient expertise to justify that reliance

2] the taxpayer provided necessary and accurate information to the adviser, and

3] that the taxpayer actually relied in good faith on the Adviser's judgment.

What does this mean in the real world?

You should get a written Opinion from the Adviser wherein he is able to list all the facts and circumstances, and apply the Tax Law to those.  That's it, really.  

In the case of REP status, the Adviser should be well grounded in IRC §469(c)(7) and IRC Reg. §1.469-5T et seq.  as well as recent case law [this is very important].  The Opinion is what protects you from the 20% penalty.  [actually the penalty could be 10% if the dollar amount of the understatement is low enough. But this is unlikely when disallowing your deductions]

So, if IRS prevails in its dispute with you, at least you will save on penalties.  

What is the cost-benefit of getting an Opinion?  Well if you took $30,000 in losses, which IRS later disallowed, you may owe $10,000.  And the penalty on that is $2,000.  That's an idea of the benefit.  The penalty you could avoid.

What is the cost?  It depends.  I would charge between $1,000 and $2,000 for such a letter with simple facts and circumstances.  More complex, more billable hours. Could be much higher.  

Is it worth it to seek advice from a competent tax adviser?  Like most things in life, you get what you pay for.  And all readers of Bigger Pockets who have to deal with professionals of all stripes have learned that lesson in spades.

And, not to state the obvious, my advice here is my opinion.  Nothing less and nothing more.