Audit Story: Here’s how our tax preparation services helped this couple beat the I.R.S. during a recent audit. The I.R.S. Lost $55,000 in This I.R.S. Rental Properties Audit!
How to Win an IRS Audit
Let me tell you about Ashley and Michael. The I.R.S. audited their income tax returns, and this is what happened:
Audit Results: The auditor examined their three rental properties, disallowed their losses, and told the couple to expect a tax bill for $55,000.
Current score: I.R.S. $55,000 ahead.
But one good thing happened during the visit. The I.R.S. agreed that Ashley was a real estate professional.
The bad thing was that the I.R.S. said that Ashley did not materially participate in the rentals because the more than 750 hours shown in her logbook included what’s called investor time.
With this, the I.R.S. examiner said that although Ashley is a real estate professional, she failed to materially participate in the properties because she had fewer than 500 hours of material participation.
Properties:
Ashley and Michael’s rental properties include
- A condo rented on a month-to-month lease,
- A single-family home rented on a month-to-month lease, and
- A vacation cabin rented on a one-week basis for 20 weeks a year.
They have no personal use of the rentals.
Our Representation, Approach, and Results:
Here’s how we helped Ashley and Michael. We started by explaining that the 500 hours are not relevant. That 500-hour rule is just one of seven possible material participation tests that you find in I.R.S. Reg. Section 1.469-5T(a)(1).
Condo. To show the I.R.S. that Ashley and Michael materially participated in the condo, we used the “more than 100 hours” test. This test requires that Ashley’s and Michael’s participation be more than 100 hours and not less than participation by any other individual.
Win. We used the Pohoski case as our position. In this court case, the taxpayer had to count only the time front-desk personnel spent on his unit, not the total time they operated the desk. The I.R.S. accepted that Ashley and Michael met that test.
Single-family home. Since Ashley and Michael did everything connected with this rental, the I.R.S. had no choice but to allow material participation under the “substantially all” test (one of the seven tests).
Vacation cabin. Ashley did all the work for the vacation cabin, except for a housekeeper who spent three to four hours for each of the 20 weeks that the vacation cabin was rented (say 3.5 x 20 weeks, for a total of about 70 hours of housekeeping). We won material participation here because Ashley’s and Michael’s combined efforts were more than 100 hours and more than the housekeeper’s 70 hours.
Win (Favorable Results for the Tax Payer)
Combining our work and Ashley’s and Michael’s good tax records enabled them to get a “no change” letter—meaning that the $55,000 IRS claim was gone.
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