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Real Estate Professional - IRS Audit
Hi Folks,
Our friends at the IRS are auditing my 2009 return, mostly because of my real estate professional designation.
I have a full time job and the rentals take up all of the rest of my time and I easily spend more time on them.
I own 10 properties with a total of 30 units. Based upon your experience, as long as I can show a weekly log (which I can) of my time spent on my properties are they going to make much of a fuss over it given the amount of real estate I own?
Thanks!
If you have a full time job, 2080 hours a year, you will need to have a detailed log that shows you spend at least 2081 hours a year on real estate related activites. I've read IRS auditing guidelines (they're on their web site) and these specifically state that managing rental properties should be assumed to require minimal time. These guidelines claims that rental management consumes a lot of time should be examined closely.
With 30 units and 2081 hours, you would need to spend 70 hours per unit per year. That's a lot more time than I do, and I manage mine myself. Now, if you're activly buying more properties, rehabbing, or whatever, that would count, too.
Al Alieo (RE tax guru) claims activities such as watching "girls gone wild" (they're potential tenants) would count, too. Personally I'd have a tough time saying that to an IRS auditor.
I may spend a little more time that most on my units because they are low-income. Which means lots of turnover, chasing down people for their rent, and many repairs.
You just need to be able to document a little over 40 hours every week in order to claim the "real estate professional" designation. Its tough to claim this designation if you have a full time, w2 job, and the IRS knows it. Probably why you were selected for an audit.
Did you keep a calendar? I got audited on this in 1994 or so, just after the designation came out. They had us come in and bring every piece of paper for 6 of our places. I had/have no job other than handling our RE. The auditor questioned whether 9 rentals (what we had at the time) would require the 12 or whatever hours per week.
This was a pretty major audit as they were looking to disallow about 140K in losses (we had some hefty legal fee's on some land we were subdividing).
The designation was new and there weren't rulings and case law to refer to. We passed muster. They ultimately decided we owed $120. I do remember showing her my full calendars of meetings, etc. relating to the properties. It may be a tough road to show 40+ hours per week when you work 40 at a regular job. Fortunately, I only had to show the minimum.
Thanks for sharing that story. Does not sound like fun. Luckily my losses in total are approx $40k, only about $15k over the normal $25k allowance. Hopefully they will find that $15k isn't worth the time and money to make this a landmark audit.
Originally posted by Roy Williams:One of the first things the auditor is likely to do is ask you for written documentation of hours you worked in your real estate business. If you can document 2081 hours of work in your real estate business you MAY have a fighting chance. If not, you fail the over 50% of time test, and you do not qualify as a real estate professional. The auditor will limit your deductible losses to the $25K. Point of fact, the IRS considers this a very easy audit, as most taxpayers don't have sufficient documentation to support the requisite number of hours to meet the test. If you haven't already met with your tax pro, I recommend that you schedule an appointment ASAP!
Thanks for sharing that story. Does not sound like fun. Luckily my losses in total are approx $40k, only about $15k over the normal $25k allowance. Hopefully they will find that $15k isn't worth the time and money to make this a landmark audit.
Originally posted by Roy Williams:
Thanks for sharing that story. Does not sound like fun. Luckily my losses in total are approx $40k, only about $15k over the normal $25k allowance. Hopefully they will find that $15k isn't worth the time and money to make this a landmark audit.
I'm quite sure they will consider $15K a large enough sum to fight with you about. They've already chosen you for the audit.
Here's the paragraph I was thinking about above:
A taxpayer, who does most of the work in a rental, meets Test 2 for material participation in Reg. § 1.469-5T(a)(2). However, if there is on-site management, it may be difficult for the taxpayer to materially participate because:1. Rental activities, by nature, normally do not require significant day-to-day involvement, i.e. they are not time intensive.
2. For many taxpayers using any kind of outside management, the only material participation test available is the 500 hour test. In many situations, the other tests will not apply.
3. In many circumstances, an individual rental activity will not require 500 hours of participation, nor will the taxpayer have sufficient time available to spend 500 hours on each individual rental real estate activity.
That's from:
http://www.irs.gov/businesses/small/article/0,,id=146326,00.html
Which is from:
http://www.irs.gov/businesses/small/article/0,,id=146318,00.html
Thanks Jon for sharing that info. I don't have onsite management so I should be OK with regards to that paragraph.
I am a one stop shop...haha
Hello Roy,
This is somewhat of a trend with the IRS. They have also audited me as well. The auditor basically told me that anyone that is claim passive rental income losses above the 25k limit is being audited. This is something the IRS believe is just a negative trend due to the housing mess we are all in. If you have a full-time job, changes are that they will not even listen to any reason or documentation. Believe me I provide alot of documentation and they still took away the deductions. This is certainly a problem for any investor, P/T real estate professional, or home owner.
Has everyone grouped their activities? Does this mean you file a written document stating that all your rentals are elected by you to be one activity? Do you refile this every year adding new properties? Or, is a one-time blanket statement sufficient? I'm sure we did this back when RE Pro came out, but????
What is with the ridiculous parsing by the IRS? Paying bills, organizing files and preparing taxes are not part of the hours required as these are "investor activities"? What? Travel time to your rental does not count?
I can't believe some of this nonsense. Fortunately I have a ton of hours. What if someone is really slow in getting stuff done and another is a whirlwind? The lazy guy qualifies and the other guy doesn't?
It seems a main audit objective is to pin you down immediately about the hours and activities. If I were going back for another audit on this, I'd be putting together some time and activity records. Do they count searching for new acquisitions or is that an investor activity?
From the IRS' perspective, if you have a full time job, it means that in order for you to qualify for RE Professional status, you'll need to be averaging more than 80 working hours per week, 52 weeks per year.
Most people don't have the stamina to work 80 hours per week consistently, month in and month out, and I'm guessing the IRS recognizes this, and knows that most people making this claim are not truly doing this.
I agree with that statement regarding the IRS' assumption. But they will have a hard time proving otherwise if your documents are in order.
Plenty of entrepreneurs work 80-100 hours per week in their businesses. It's killing me. I've had 3 properties listed for sale for the past 2 years and can't unload them. 10 properties is too much.
I too claimed the RE professional designation in 2009 with an amended return to take the benefits. My wife became a real estate agent in 2010 and spent the "required" time managing our 5 properties in 2009 and 10 in 2010. Can I expect an audit here or is the stay at home wife bulletproof?
Originally posted by Serge S.:
I too claimed the RE professional designation in 2009 with an amended return to take the benefits. My wife became a real estate agent in 2010 and spent the "required" time managing our 5 properties in 2009 and 10 in 2010. Can I expect an audit here or is the stay at home wife bulletproof?
The designation of real estate professional will not in and of itself trigger an audit. That being said, claiming losses in excess of $25k may very well trigger an audit, particularly since you filed an amended return to claim the benefits. That's one of the things IRS is taking a hard look at. And no, the stay at home wife is NOT bulletproof. If your wife is the individual claiming RE professional status, she will have to have written documentation to show that she meets the requirements for the designation. And just so you know, most auditors will NOT count her hours as a real estate agent as work in your real estate business. The code specifies "brokerage activities" not "selling real estate."
Serge, the stay at home wife is possibly your lucky hand in doing fine. Now for the others if anyone has any questions don't hesitate to e-mail me if they need additional help. I'm currently working on several audits regarding this.
Review Jon's post very carefully that will be what helps you. However, the auditor may disallow the expenses completely based upon the fact you have a full time job.
Another thing; don't bring the auditor anything more than they ask for, and if possible have someone represent you. Because what they don't know helps you. Often topics are dropped because your rep does not know the answer. The last thing you want to do is go in yourself if at all possible.
Originally posted by Steven Hamilton II:
Serge, the stay at home wife is possibly your lucky hand in doing fine. Now for the others if anyone has any questions don't hesitate to e-mail me if they need additional help. I'm currently working on several audits regarding this.
Hi Steve, do you mind shooting me an email at: [REMOVED]
Thanks!
Review Jon's post very carefully that will be what helps you. However, the auditor may disallow the expenses completely based upon the fact you have a full time job.Another thing; don't bring the auditor anything more than they ask for, and if possible have someone represent you. Because what they don't know helps you. Often topics are dropped because your rep does not know the answer. The last thing you want to do is go in yourself if at all possible.
Thanks to Jon for posting the links. I printed out the audit questions and other stuff.
Steve, we didn't take a rep. My father, an attorney - but not Tax, thought it would "escalate things". I did get a couple kicks under the table from my husband when I started to volunteer info that wasn't asked.
Originally we were told that they were looking at two specific things and when we got there she asked for everything on six properties. Fortunately, my husband keeps excellent records on each property and I am quite sure the agent was impressed when she saw what was couriered over to her the next day.
I wish now that I had kept all the e-mails I had regarding tenant and property issues. I don't keep a calendar anymore having gotten into the bad habit of writing stuff on scraps of paper. Steve, do you suggest that everyone claiming RE Pro prepare a summary at this time? I would be concerned that if they disallowed one year, they will go back two more.
I just got off the phone with my handyman and this is the type of stuff I never write down. I can reconstruct things by reviewing checks and invoices but this would only be a small part of what I do.
I guess I am not too worried if they aren't requiring contemporaneous (sp?) records. I am getting a little paranoid since the calandars seemed important in our last audit. My husband will kill me if it turns out I don't have the proof required. We are talking big numbers.
I do know people who are phased-out and claimed this status with only 2 or 3 properties. This is probably what they are targeting. I'd guess they look at the schedule E (for number of properties) and look for w-2 income before considering an audit. I think I'll do a monthly summary while things are still fresh in my mind.
btw - our last audit came about a year after the return was filed. I assume the timing hasn't changed.
IRS is auditing my 2009 tax year...and I received notice this spring. I think anything prior is outside their scope.
Roy, I PMed you my contact information.
Also, I have 3 clients at the moment who's 2010 returns are being looked at by an auditor.
Cheryl,
All records every year should be put together in a fashion that if the IRS were to audit you, all you would have to do is pull out those items from your files. How else do you get the final numbers for your tax return? Also, just because you qualify as an RE Professional one year, does not mean you will the next.
When you work with a handyman, just put down, "Worked with handyman on x problem for x property.
And yes those are some of the reasons audits are picked, the computer sees X amount of w-2 income and x amount of RE losses and you get hit with an audit, the key is to win it with no change, so that way the they can't audit you on the same thing for a few years.
I highly recommend creating summaries and calendars. I have a calendar for each one of my activities. I have several different sources of income.
Sorry I jumped around a bit, working and replying here.
Thanks Steve. I have extremely well documented files for every property - just not a calendar. I doubt I will have an audit problem. Just need to put together an estimate of time. I have no PM, rent my own units, no "job" and 20 rentals.
For others: the agent requested all leases, receipts, bank statements, cancelled checks, mortgage statements, tax bills, insurance bills...etc., etc.
We got our IRS "white" legal size envelope yesterday for a "Real Estate Professional" audit for tax year 2009. Quickly did some research and do not see a way out of this (at least through a quick calculation of the math problem before us). We both have full-time W-2 jobs, and 100% manage and operate two single-family rentals.
What is the best way to "throw in the towel"?
If we need to bite the bullet, then so be it. Not sure wasting our time, the IRS, or the time of a skilled lawyer, is worth the effort when the numbers look hard to achieve (and be IRS accepted). Please correct me if I am wrong (glimmer of hope). Thanks for your help.
Dave, feel free to send me PM or an e-mail and we can discuss your audit.
Roy,
If you failed to file a written statement with your tax return that your properties are grouped into a single real estate activity, the IRS will treat each property as a single and separate real estate activity. This means that you will have 10 real estate activities. For Real Estate Professional status for each of your 10 real estate activities, you must be able to prove that at least 750 hours per year were devoted to that real estate activity and that you materially participated. This is in addition to meeting the more than 50% of total time rule for your real estate activities.
Dave O --
Did yo really think you were going to get away with claiming the RE professional status and having two rentals?
Just curious
If we need to bite the bullet, then so be it. Not sure wasting our time, the IRS, or the time of a skilled lawyer, is worth the effort when the numbers look hard to achieve (and be IRS accepted). Please correct me if I am wrong (glimmer of hope). Thanks for your help.
Hi George P.,
It is not about getting away with anything versus not fully understanding the specific details to a "Real Estate Professional", per the IRS code, and making too much money.
I am good with "Material Participation" and "Service Hours"(we do everything ourselves). The kicker is the W-2 jobs (along with the salaries that come with them), and the need for the real estate "Service Hours" to be greater than the W-2 hours, and the "Modified AGI" to be $100k or less.
For a full-time W-2 job, I do not see how anyone satisfies this part without some inflation (I am not pointing fingers, just saying). Perhaps the IRS allows (or tolerates) inflated hours under what is "reasonable". If we only knew the upper limits for activities, as if the IRS would ever publish that.