File As "Real Estate Professional"? 1099?

Question

Trying to decide how to file our 2018 taxes. Wife and I retired a couple years, except for the part about working all day, most days. We have a house that is and has been our residence for many years. We also have other active rental property, which we completely DIY except HVAC (including extensive rehabs, for months at a time, as needed, over several years), and more recently, we have an empty 3000 sq. ft. foreclosure about 30 minutes from our residence. Previously we have filed taxes jointly, as retired, with rental property.

Since early January, 2018, we've been doing a rehab of the foreclosure. We worked there all year, more or less full time, except taking two months to work full time to do maintenance and upgrades, between tenants, on another rental, and maybe 8 weeks traveling and visiting family and friends.

My sister came from out of state to visit, and to work. She registered as a business locally, an LLC, and worked as a contractor, giving a written bid and description of work for each job, and an invoice upon completion of each:

Wallboard in family room, replace and repair as needed. $650.
Wallboard in rec room, R&R, $450.
Prime and paint 3 bedrooms, $450.
Remove texture from bedroom ceiling, skim coat, prime and paint, $250.
Tear off old roof shingles and load into dump trailer, $600.
Install walkway of paver bricks, $350.
Pressure wash non-brick parts of exterior, $300.
Etc, etc.

So, after maybe five months, we had paid her about $11,000, and she went back home.

Can/should I file as a "real estate professional"? Are there any advantages? Downsides?

Should I send a 1099 to my sister? Under what conditions? It seems if I'm not in business, I shouldn't. But it seems like I'm in business...

Brandon Hall · Answer

There are plenty of advantages to claiming the real estate professional status. One such advantage is that, assuming you also materially participated in your rental activity, you can take an unlimited amount of passive losses.There can also be disadvantages. The biggest mistake we see is that RE Pros keep really shabby time records which allows the IRS to throw out the election under audit. So a disadvantage is an increased admin workload.If you claim RE Pro, you should go ahead and file a Form 1099 for any contractor you paid over $600 during the year. Claiming RE Pro does not necessarily mean your business will rise to level of trade or business, which would require you to file Form 1099s, but it can’t hurt to be safe.I do want to warn you that RE Pro is a confusing piece of the tax code. I highly recommend that you do not file your taxes and use this strategy without consulting a CPA. There are many areas where you can make mistakes that will lead to costly penalties if you’re not careful.

Kristen Schaefer · Answer

@Brandon Hall Thank you for all you contribute! I'm new to the community and I recently downloaded and read your REPS guide. I also had a meeting with Lew Grant and considering coming on board as a client. I am stumped on one part of REPS that you mentioned in your guide. You said you need to own 5% of the business you are materially participating in. If outside of managing my rentals I work as an unofficial "property manager" (I'm not licensed in CT) for my in-laws managing 2 of their long-term rental properties. Can I count those hours? I am paid directly by a check in my name, there is no official business, and I do not receive a 1099 form from them at the end of the year. They pay me $6K annually. Your guide mentions you need to own at least 5% of the business if you are an employee, but since I am working as a sole proprietor would these hours count? Does the IRS care if by CT laws for official property management? bhall005

Frank Chin · Answer

I've been the recipient of 1099's and over the years, and in the position of issuing them as well, though not for real estate. Based on the information provided, you may be considered a borderline RE professional and to play if safe, issue a 1099. You have to make sure the contractor issued the 1099 is for his labor part, not materials. I've issued separate checks for labor and materials, for my bookkeeping convenience, though you can separate the expense items on the check remittance advice.Just to say if you're gung-ho on doing the 1099, just do it, you don't need time logs justifying it. I read on these forums folks issue phony 1099's to harass people, landlord issue them to tenants for unpaid rent, just to send them a scary message. Doubt these guys keep a time log.The one thing that bothered me the most is some issuers of 1099's issue them willy nilly with no consideration for the recipients. Remember that erroneous 1099's can cause recipients headaches, as I was the subject of a tax audit due to one. Your sister might be in the same boat as I at the time, a new contractor getting started. People use LLC's so they can deduct their business expenses. Say if she only had you as a client for the year, got a 1099 for $11,000 , on the tax returns, show $1,000 in business income because of business deductions, it could trigger an audit. The client that issued me the erroneous 1099 include much more than labor on my 1099, inflating it, which I believe raised a red flag after I deducted business expenses. When I met my client, I was pretty peeved, with him telling me he 1099 everyone to play it safe. As an S Corp, he didn't even have to 1099 me, though not illegal. The IRS finally agreed I was correct, and requested a corrected 1099 from them, which they never issued.Remember, when the IRS does an audit, you have to go back several years to dig up the files, and get after the issuer, a time consuming task. Wasted days of time and effort on my part because my client didn't know what he was doing, besides the stress, and the President of the firm was a CPA, though the lazy bookkeeper there couldn't care less.Bottom line is, your sister may get a tax audit so you can play it safe, and play real estate professional, which you don't necessarily have to do.

Steven Hamilton II · Answer

There is no requirement for a landlord to issue 1099s to contractors. Nor is there a requirement for Real Estate professionals to do so. There is a currently argument since the IRS has been silent on the issue in the new tax law about defining your Real Estate activity as a trade or business. This entirely depends upon how you operate. I recommend having a written business plan, issuing 1099s and maintaining detailed records include an Income Statement and a Balance Sheet as any other business would.

Mike C. · Answer

Thanks much for all the replies and info.Any comments on these following conclusions would be welcome.I qualify under IRS rules as a Real Estate Professional because:I work actively, hand-on, well over 1000 hours per year, in real estate: finding, buying, DIY rehabbing, renting, managing, refinancing and maintaining properties.I keep a log of time spent and tasks performed.I should file a 1099-MISC for paying about $11,000 to a freelance home improvement contractor operating as an LLC but filing as non-corporate, for various repairs and improvements to a property I own solely for the purpose of rehabbing and renting.When in doubt, it's better to file a 1099 then to not. I should consult with/hire a CPA for 2018 taxes, filing as a Real Estate Pro, and to review our previous 3 years of tax returns in case they contain errors or omissions.

Frank Chin · Answer

There's a recent thread on 1099's where the issues are discussed:Issuing 1099'sIn particular, see the article on small landlord exception: Small landlord exceptionI was doing consulting for businesses and have to make discussions to 1099 or not. To do it properly, you don't 1099 corporate entities and 1099 only for labor, but not for materials. I was a contractor once, got an IRS audit because he reported all checks issued to me on a 1099 including the sales of goods. The IRS thought I was cheating on my taxes. I was an S Corp and don't even have to be 1099'd.As filing as a Real Estate professional, it has to do with many factors, whether you spent more than 500 hours on real estate activities. It has nothing to do with how long it took her to do the work. For you, it's more likely a passive activity. See definition of real estate professional:Real estate professionalWhen I issued 1099's, if a contractor used a EIN# on their W9, and for companies that 1099, I do not issue a1099 to them taking the position it's a corporate entity. Some may argue that it could be a pass through entity.If you can consider yourself exempt form 1099, that would be the best approach. The IRS wanted the issuer of the 1099 that caused me all that grief to issue a corrected 1099, which they never did. I followed them up for over a year thinking the IRS was on my tail. As others has said, consult a CPA since it's not that simple.

Victor N. · Answer

Unless your sister's LLC files as a corporation, you will have to send her a 1099. It is very likely that she files as a disregarded entity which will require a 1099