Material Participation - what constitutes good recordkeeping?

[Bruce D. Kowal]

IRS will challenge the 750-hour requirement under §469(c)(7)(B)(ii).   The Temp Regs set forth the requirements to establish hours of participation §1.469-5T(f)(4):  

"The extent of an individual's participation in an activity may be established by any reasonable means.  Contemporaneous daily time reports, logs, or similar document are not required if the extent of such participation may be established by other reasonable means.  Reasonable  means  . . .may include but are not limited to the identification of services performed over a period of time, and the approximate number of hours spent performing such services during such period, based on appointment books, calendars, or narrative summaries."

Fine.  How does this work out in an IRS audit?  Fortunately in a Tax Court case from 2018, IRS challenged Roberta Birdsong's 750 hours [Birdsong v.  CIR, T.C. Memo 2018-148  https://www.courtlistener.com/...].  She won her case.  

This is how her record keeping was characterized. This is worth reading.

"[She] was the sole party actively involved in the day-to-day management of their rental properties.  These tasks included, inter alia, cleaning common areas, collecting coins from washing machines, performing repairs at their properties, communicating with tenants, collecting and depositing rent, maintaining insurance policies purchasing materials for the properties as needed, paying bills and keeping book and records for tax accounting purposes.  She occasionally hired a contractor (such as handyman or plumber) to perform tasks she could not complete herself.  When she hired a contractor . . .[she] spent considerable time researching and contacting contractors, obtaining price quotes, and supervising repairs.  [Her] management duties also included inspecting units, preparing (painting and supervising contractors) units for rental, advertising vacant units, screening potential tenants, showing the units, and processing rental applications."

Good grief!  She was busy.  And what kind of record keeping system satisfied the Tax Court Judge?

"[She] produced two spreadsheets detailing her rental management activities.  The first spreadsheet reflects that [she] logged 844.75 hours managing the rental properties . . .  The second spreadsheet includes previously omitted tasks such as investor hours and driving time between rental properties and the hardware store and other locations pertinent to the management of the units.  [She] used her calendar and receipts to reconstruct the time entries on both spreadsheet for the first half of 2014.  For the second half of 2014, the time entries come from a contemporaneous log [she] maintained on her phone on which she entered the date, location, time, and description of each task she performed.  [She] wife receipts and invoices that substantiate the hours she logged."

At the hearing in the US Tax Court, Mrs. Birdsong represented herself.  She did not use a tax lawyer.  This is called "Pro Se".  Likely, she was well coached by the CPA who prepared her tax return.  What did the Judge think of her testimony?

"[She] testified credibly and in detail about [her] active and extensive management of the rental properties.  [Footnote 5:  We find [her] to be honest, forthright, and credible]. Furthermore, [she] presented detailed spreadsheets that reflected [her] rental management activities exceeded the 750-hour requirement.  We find [her] narrative summary and thorough time logs convincing because [she] owned numerous rental units that she operated alone.  [Her] testimony is further buttressed by [her] thorough time-keeping as well as the receipts and invoices [she] produced to corroborate her time logs."

Is there a lesson here?  Sure. It's obvious.  Keep detailed contemporaneous logs of time and expenses.  Work with a competent CPA to oversee this during the year.

As for 2022, yes, five months have elapsed, but it's not too late to reconstruct a log from January and get on the straight and narrow path to defending your Real Estate Professional status in 2022.  Consult your CPA about this.  Always assume you will be audited, and you will prevail.

This is the type of information you should expect to find on Bigger Pockets.  Right?

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