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Lisa and Jimmy got audited by the I.R.S. This is what happened.
They had an excruciating meeting with the I.R.S.
The auditor examined their three rental properties, disallowed their losses, and told them 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 Lisa was a real estate professional.
The bad thing was that the I.R.S. said that Lisa 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 Lisa is a real estate professional, she failed to materially participate in the properties because she had fewer than 500 hours of material participation.
Lisa and Jimmy’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.
Representation Approach and Results:
Here’s how we helped Lisa and Jimmy. 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 Lisa and Jimmy materially participated in the condo, we used the “more than 100 hours” test. This test requires that Lisa’s and Jimmy’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 that front-desk personnel spent on his unit, not the total time they operated the desk. The I.R.S. accepted that Lisa and Jimmy met that test.
Single-family home. Since Lisa and Jimmy did everything in connection 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. Lisa 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 Lisa’s and Jimmy’s combined efforts were more than 100 hours and more than the housekeeper’s 70 hours.
Win (Favorable Results for the Tax Payer)
The combination of our work and Lisa’s and Jimmy’s good tax records enabled Lisa and Jimmy to obtain a “no change” letter—meaning that the $55,000 IRS claim was gone.
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