Tax Court Rules Against Attorney Claiming Real Estate Professional

The name of the case: Hakkak v. Commissioner, (TC Memo 2020-46)

Date opinion was issued: April 13th, 2020

The issue: The tax court was deciding whether the taxpayer, a California personal injury attorney, was a real estate professional as it related to his activities in certain flow-through entity investments owning rental property.

His tax returns claimed: The taxpayer reported his losses from his real estate activities as passive losses. Then, he used those losses to reduce his shareholder income from his personal injury law practice which he also claimed as passive income. 

The IRS claim: The IRS said that the income from his attorney practice was nonpassive income and therefore could not be reduced by the passive losses from his rental activities.

Strange trial proceedings: The taxpayer ended up arguing in the tax court that the income from his real estate activities were nonpassive. He then argued that the nonpassive nature of his real estate losses could then offset the nonpassive income from his law practice. (It was strange because his tax return had claimed the law practice income as passive income but in the tax court he was arguing it was nonpassive). 

The taxpayer's claim: The main claim the taxpayer was making was that he was a real estate professional and, therefore, the real estate losses should be nonpassive. As a real estate professional, he claimed, the real estate losses should be able to reduce his personal injury law income.

Real Estate Professional: What is a real estate professional per the IRS? A taxpayer is a real estate professional if during the taxable year, the taxpayer spent more than 750 hours AND more than half of his/her personal service hours in a real estate trade or business. In addition to this, the taxpayer must materially participate in the real estate activity for it to be treated as nonpassive. There are lots of tax court cases that flesh these requirements out based on real world scenarios.

Findings: The tax court decided that there was not enough evidence to support his real estate professional claim. He couldn't establish enough evidence of his hours of participation by reasonable means. And, his investor-type activities didn’t count toward the 750 hour requirement.

Conclusions: If you're going to be claiming yourself as a real estate professional, be aware, there are lots of rules that should govern that decision.