How To Represent Real Estate Investors, Real Estate Professionals, And Everything In Between

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Download Original Article Full version A&A Newsletter – March 2016

By Frank Agostino, Esq. & Patrick Binakis, Esq.

Routinely at issue in tax controversies is the extent to which (if at all) a taxpayer who is involved in rental real estate activities may deduct losses related to that activity. Not surprisingly, because the ability to use passive losses to offset active income, taxpayers who own rental real estate activity frequently (and often improperly) treat themselves as “real estate professionals” when they are in fact real estate investors. Given the prevalence of this issue at United States Tax Court calendars, tax controversy professionals must frequently prove a client’s qualification for real estate professional status. Effective trial representation of a client faced with this issue requires familiarity with the relevant statutes, case law, trends, and factors courts will consider when determining whether a taxpayer is a real estate professional or a real estate investor. This article begins with an overview of often-overlooked rules that can apply to taxpayers with rental real estate activities. Then, this article discusses the most common ways that these issues arise in litigation, namely, satisfying the 50% and 750-hour requirement under section 469(c)(7)(A) of the Internal Revenue Code, and ensuring that the election to aggregate rental real estate activities is properly made.

I. Overview: Passive Activity Loss Rules and Exception for “Real Estate Professionals”

A. General Rule: Deductions

Under sections 162 and 212, taxpayers are generally allowed deductions for all the ordinary and necessary expenses paid or incurred in connection with a trade or business or for the production of income.2 Section 469, however, may limit the deductibility of losses from these activities where the losses arise from passive activities.3 A passive activity is any activity which involves the conduct of any trade or business and one in which the taxpayer does not materially participate.4 Rental real estate activity is generally treated as a per se passive activity regardless of whether the taxpayer materially participates.5 The disallowed passive activity loss equals the excess of the aggregate losses from all passive activities for the year over the aggregate income from all passive activities for that year.6

A taxpayer may avoid having his or her real estate activity classified as a per se activity if the taxpayer is a qualifying real estate professional.7 In such cases, the taxpayer may deduct losses from rental real estate activities without regards to the passive activity loss limitations.8 Also, a taxpayer who actively participates in a rental real estate activity may deduct up to $25,000 in rental real estate losses so long as the taxpayer actively participates in the rental real estate activity and his or her adjusted gross income is $100,000 or less.9 For taxpayers who actively participate in the rental real estate activity and whose adjusted gross income is above $100,000 but less than $150,000, the $25,000 amount is reduced by 50% of the amount by which the taxpayer’s adjusted gross income exceeds $100,000.10

The difference between material participation and active participation is fine and distinct. Material participation is involvement in the activity that is regular, continuous, and substantial.11 As applied to a rental real estate activity, active participation is involvement in the making of management decisions or arranging for others to provide services in a significant and bona fide sense.12

B. Exception to Passive Activity Loss Rules: Real Estate Professionals

The first exception to the general rule that rental real estate activities are per se passive activities is found in section 469(c)(7). Pursuant to that section, the rental activities of a taxpayer who is a real estate professional are not per se passive activities but are treated as a trade or business subject to the material participation requirements of section 469(c)(1).13 In order for a taxpayer to qualify as a real estate professional, the following two tests must be met:

(1) more than one-half of the personal services performed in trades or businesses by the taxpayer during such taxable year are performed in real property trades or businesses in which the taxpayer materially participates, and

(2) such taxpayer performs more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates.14

The term “real property trade or business” means “any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.”15 In the case of a joint return, the requirements for qualification as a real estate professional are met if either spouse separately satisfies the requirements.16 Note that the taxpayer must prove that more than one-half of the services the taxpayer performs must be in real property trades or business in which the taxpayer materially participates. 17 As noted, section 469(h)(1) generally (and somewhat amorphously) provides that a taxpayer shall be treated as materially participating in an activity if the taxpayer is involved in the operation activity on a basis which is regular, continuous, and substantial. The Temporary Treasury Regulations clarify this amorphousness insofar as they generally provide that a taxpayer can establish material participation if any one of the following seven tests is satisfied:

(1) The individual participates in the activity for more than 500 hours during such year;

(2) The individual’s participation in the activity for the taxable year constitutes substantially all of the participation in such activity of all individuals (including individuals who are not owners of interests in the activity) for such year;

(3) The individual participates in the activity for more than 100 hours during the taxable year, and such individual’s participation in the activity for the taxable year is not less than the participation in the activity of any other individual (including individuals who are not owners of interests in the activity) for such year;

(4) The activity is a significant participation activity … for the taxable year, and the individual’s aggregate participation in all significant participation activities during such year exceeds 500 hours;

(5) The individual materially participated in the activity … for any five taxable years (whether or not consecutive) during the ten taxable years that immediately precede the taxable year;

(6) The activity is a personal service activity …, and the individual materially participated in the activity for any three taxable years (whether or not consecutive) preceding the taxable year; or

(7) Based on all of the facts and circumstances …, the individual participates in the activity on a regular, continuous, and substantial basis during such year.18

The extent of an individual’s participation in an activity may be established by any reasonable means.19 Although courts have expressed a preference for contemporaneous daily time reports, logs, or similar documents, such documents are not the exclusive means by which material participation can be proven.20 The work performed by the taxpayer’s spouse in a rental real estate activity is treated as work performed by the taxpayer, regardless of whether the spouses file a joint return for the year.21

For taxpayers with multiple rental properties, the general rule is that each property is treated as a separate activity for which the taxpayer must separately satisfy the material participation requirement.22 However, an important exception to this general rule is that a taxpayer may elect to treat all interests in rental real estate as a single rental real estate activity pursuant to section 469(c)(7) in the manner required by Treas. Reg. § 1.469-9(g)(3).23 As discussed below, whether a taxpayer is a real estate professional has been an issue which has engendered considerable litigation.

C. Exception to Passive Activity Loss Rules: Active Participation

The second exception to the general rule that rental real estate activities are per se passive activities is found in Section 469(i). This exception allows eligible taxpayers who actively participate in a rental real estate activity to deduct up to $25,000 of losses arising from the activity.24 As explained above, the active participation standard is a lower bar to meet than the material participation standard.25 The full $25,000 loss is permitted if the taxpayer’s adjusted gross income (AGI) is less than $100,000.26 This permitted loss is reduced by 50% of the taxpayer’s AGI in excess of $100,000, and as modified income exceeds $100,000, the allowable $25,000 offset is phased out as AGI, with a full phase-out occurring when modified AGI equals $150,000.27 As discussed below, especially for middle-income families who do not rise to the level of real estate professionals, the active participation requirement can create significant tax savings for such taxpayers.

D. Net Investment Income Tax and Real Estate Professionals

Section 1402 of the Health Care and Reconciliation Act of 201028 outlines the unearned income Medicare tax, which went into effect on January 1, 2013.29 Under that provision, taxpayers with modified adjusted income over $200,000 if filing individually or $250,000 if filing jointly as a married couple could be subject to this tax.30 The provision imposes a 3.8% tax on unearned income—income from all passive activities, including interest, dividends, annuities, royalties, and rents. The tax does not apply to income from an actively conducted business.31

Individuals who qualify as real estate professionals are not liable for this tax.32 That is, they are not subject to the 3.8 percent tax on rental income if they “materially participate” in the real estate activity and the activity qualifies as a business for tax purposes.33 In this regard, the new regulations establish a “safe harbor” rule for when a rental activity conducted by a real estate professional is a business: So long as a real estate professional devotes a minimum of 500 hours per year to the rental real estate activity, such activity will automatically qualify as a business for these purposes and the rental income will not be subject to the section 1402 tax.34 Alternatively, if a real estate professional has participated in rental real estate activities for more than 500 hours per year in five of the last 10 tax years, the rental activity will qualify as a business.35 There are currently no cases interpreting these provisions.

II. Often-Litigated Issue #1: Failure of Substantiation as to Real Estate Professional or Active Participant

A. Proving Qualification as a Real Estate Professional

Substantiation (or lack thereof) is routinely at issue in tax cases involving taxpayers with rental real estate activities. Indeed, one of the biggest stumbling blocks taxpayers run into in attempting to qualify a real estate professional is the inability to substantiate the time spent in their activity to show that the requirements of section 469(c)(7)(B)(i) and (ii) are met. As previously noted, the Temporary Treasury Regulations provide that

the extent of an individual’s participation in an activity may be established by any reasonable means. Contemporaneous daily time reports, logs, or similar documents are not required if the extent of such participation may be established by other reasonable means. Reasonable means for purposes of this paragraph may include but are not limited to the identification of services performed over a period of time and the approximate number of hours spent performing such services during such period, based on appointment books, calendars, or narrative summaries.36

In a number of recent cases, taxpayers have had difficulty providing records to support that they engaged in the rental real estate activity on such a continuous basis as to meet the requirements of section 469(c)(7)(B)(i) and (ii). For example, in Coastal Heart Medical Group, Inc. v. Commissioner, the taxpayers testified (without supporting documentation) that they spent 14-to-16 hours a day, seven days a week negotiating the purchase of hospitals in a particular year.37 The United States Tax Court (“Tax Court”) held that even though the regulations permit some flexibility regarding the records to be maintained by taxpayers, the Court is not required to accept a postevent “ballpark guesstimate” or the uncorroborated testimony of taxpayers.38 Thus, although the Treasury Regulations do not strictly required it, the taxpayer is advised to offer a log, calendar, or other contemporaneous writing to prove the amount of hours he or she worked in his or her rental real estate activity.39

In Moss v. Commissioner, 40 the married taxpayers contended that, in addition to the time one of them actually worked, the hours that the husband was “on call” for work on the rental properties should also count towards determining whether the taxpayers met the requirements of section 469(c)(7)(B). The Tax Court disagreed and held that the taxpayer’s “on call” hours may not be used to satisfy the 750–hour requirement of section 469(c)(7)(B)(ii).41 The Court reasoned that, although the taxpayer could have been called in to perform services, he never performed such services, and section 469(c)(7)(B)(ii) requires the Court to look to the hours actually performed by the taxpayer.42

In Jafarpour v. Commissioner, the Tax Court comprehensively analyzed why the taxpayer did not qualify as a real estate professional.43 The Court looked to a number of facts to support the finding that the records produced were not reasonable or reliable, including the illegibility of the taxpayer’s appointment book, the lack of contemporaneousness of the logbook, inconsistencies between the taxpayer’s phone records and the time recorded in the logbook, her claim of taking one hour to read a one-sentence e-mail on multiple occasions, and suspect entries in her logbook claiming she toured an area “to get a feel” for the schools and shopping, and overall. The Court characterized these entries as “unreasonable assertions … so pervasive that the entire log is tainted with incredibility.”44 Thus, Jafarpour compels the conclusion that taxpayer’s must not only have records of the hours they spent on a particular activity, but that the records must be reasonable and reliable.

An issue which often arises in the real estate professional context is that the taxpayer’s records may have been destroyed.45 The Tax Court has not left such taxpayers without recourse. The Tax Court has held that a taxpayer “is entitled to substantiate deductions by reconstructing his expenditures through other credible evidence.”46 Thus, in appropriate circumstances, the Tax Court may be willing to accept post-event reconstruction from contemporaneous documentation rather than post-event reconstruction from memory.47

In Escalante v. Commissioner, 48 the Tax Court held that the taxpayer’s logs recording the number of hours spent annually on rental real estate activity versus the hours he spent in his regular profession as a teacher were insufficiently reliable to establish he met the requirements to avoid the passive loss limitations on deductions for rental real estate activity. When reviewing the taxpayer’s hours spent on non-real estate activity as a teacher, the Court concluded that the failure to include any hours outside the minimum time required under the teacher’s contract made it indeterminable whether the taxpayer spent more time as a teacher or in his real estate activities. 49 In addition, the reliability of the logs were also called into question by what appeared to be exaggerated amounts of time shown for relatively routine, recurring events, such as check writing.50

In sum, the following key points can be derived from the various case law:

1. Even though the regulations permit some flexibility regarding the records to be maintained by taxpayers, the Tax Court is not required to accept a post-event “ballpark guesstimate” or the uncorroborated testimony of taxpayers.
2. The taxpayer’s “on call” hours may not be used to satisfy the 750–hour requirement
3. The taxpayers must not only have records of the hours they spent on a particular activity, but the records must be reasonable and reliable.
4. With regard to taxpayer records that may have been destroyed, the Court may be willing to accept post-event reconstruction from contemporaneous documentation rather than post-event reconstruction from memory.
5. Failure to include any hours outside the minimum time required under a taxpayer’s non-real estate job can make it indeterminable whether the taxpayer spent more time at that job or in his real estate activities.

B. Proving Active Participation

If a taxpayer does not have records to support that he or she meets the two-prong test in section 469(c)(7)(A), tax professionals should next consider whether the taxpayer qualifies under the active participation exception of section 469(i)(1).51 Litigation on this topic is scarce, most likely because the active participation threshold is so easily met, but courts have generally been willing to find the existence of active participation. In this regard, the Internal Revenue Service (“Service” or “IRS”) instructs as follows: “As long as a taxpayer participates in management decisions in a bona fide sense, he actively participated in the real estate rental activity.”52 The standard to prove active participation is a lot less stringent for a taxpayer to meet in comparison to how the courts review the evidence needed to prove qualification as a real estate professional.53 Taxpayers usually do not qualify for the $25,000 deduction under this exception, not for the inability to substantiate their expenses, but because their modified gross income is over $100,000.54

III. Often-Litigated Issue #2: Failure to Make the Aggregation Election

A. Background: How to Make and Revoke the Aggregation Election

Another issue that is often litigated is whether the taxpayer is able to treat multiple rental real estate activities as a single rental real estate activity. As noted above, for taxpayers with multiple rental real estate properties, meeting the material participation requirement for each property separately can be difficult. This is because the default rule is that each property is treated as an independent activity for which the taxpayer must satisfy the material participation test, unless the taxpayer elects to treat all interests in the rentals as a single activity.55

A taxpayer makes this election by filing a statement which explicitly declares that the taxpayer is a qualifying taxpayer (i.e., the taxpayer meets the requirements to be a real estate professional) for the tax year and is making the election under Section 469(c)(7)(A).56 After making this election, it is binding for the tax year in which it is made and for future years in which the taxpayer is a qualifying real estate professional, even if there are intervening years in which the taxpayer does not qualify as a real estate professional.57 This election can be revoked by the taxpayer only in the tax year in which “a material change in the taxpayer’s facts and circumstances occurs or in a subsequent year in which the facts and circumstances remain materially changed from those in the taxable year for which the election was made.”58 To revoke the election, the taxpayer must file a statement with an original return for the year of revocation containing a declaration the taxpayer is revoking, and an explanation of the nature of the material change.59 The IRS also allows certain taxpayers to file a late election after filing their original tax return by attaching a statement to the amended return for the most recent tax year and mailing the amended return to the IRS service center where the taxpayer will file the current-year return.60

B. Effect of Failure to Properly Make the Aggregation Election

In Kosonen v. Commissioner, the Service conceded that the taxpayer materially participated in his rental real estate activities and was able to deduct expenses without application of the passive activity loss limitation rules if the activities were treated as one activity, because the taxpayer elected under section 469(c)(7) to treat his various rental real estate activities as one activity.61 The Tax Court found that the taxpayer did not properly make the election, and that he did not separately meet the requirements of section 469(c)(7)(A)(i) and (ii) for each rental activity. The Tax Court ruled that, in order to make an election, a taxpayer, must clearly notify the Service of his or her intent to do so.62 Specifically, the Court stated, “The taxpayer must exhibit in some manner … his unequivocal agreement to accept both the benefits and burdens of the tax treatment afforded” by the statute.63 The Court did not agree with the taxpayer’s contention “that he treated his net losses as active [and intended to make the election because] he reported on lines 22 through 26 and 42 of Schedule E, line 1d of Form 8582, and statements in support of Form 8582 of his 1994 return that, except for one property, none of the properties had a passive gain or loss and that he did not add his 1994 losses to previously suspended losses.”64

Furthermore, the Court observed that the taxpayer’s mere reporting of his losses as active losses is not clear notice that he made the election because he also would have reported that his net losses were active if he had materially participated in each of the seven rental real estate activities and had not made the election under section 469(c)(7).65 In addition, the court refuted the taxpayer’s claim that his intent to make the election should be taken into consideration and held that a “taxpayer’s intent is irrelevant to making an election.”66 Thus, it is important that the taxpayer memorialize his or her intent to make the aggregation election under section 469(c)(7) by filing the statement required by Treas. Reg. § 1.469-9(g)(3).

C. Filing a Late Election

Rev. Proc. 2011-34 allows certain taxpayers to file an election after filing their original tax return by attaching a statement to their amended return for the most recent tax year and mailing the amended return to the IRS service center where the taxpayer will file his or her current-year return. Stated simply, in addition to the information required by Treas. Reg. § 1.469-9(g)(3), a taxpayer filing a late amendment must include:

1. An explanation of why the election was not timely made;

2. Designation of the tax year for which the taxpayer seeks to make the late election;

3. Representations that the taxpayer:

• Failed to make an election under Treas. Reg. § 1.469-9(g) solely because the taxpayer failed to meet timely the requirements in that section;

• Filed consistently with having made an election under Treas. Reg. § 1.469-9(g) on any return that would have been affected if the taxpayer had timely made the election;

• Timely filed each return that would have been affected by the election if it had been timely made; and

• Has reasonable cause for failing to meet the requirements in Treas. Reg. § 1.469-9 (g).

4. A declaration that the representations are made under penalties of perjury; and

5. A statement at the top declaring: “FILED PURSUANT TO REV. PROC. 2011-34.” The individual or individuals who sign must have personal knowledge of the facts and circumstances related to the election.

There are currently no reported cases where the Court has accepted a Rev. Proc. 2011-34 election filed after the issuance of a notice of deficiency. It should be noted that we have been involved in cases where the Tax Court judges have continued cases of pro se taxpayers set for trial so that the IRS could consider a late-filed election and have indicated that the rejection of the election may be reviewable by the Court under an abuse of discretion standard.

D. Downside of the Aggregation Election

The aggregation election is not always beneficial. One of biggest drawbacks of making the aggregation election, is the adverse impact such an election may have under the section 469(g) “complete-disposition rule.” This section provides that passive losses that have been suspended are generally allowed when the taxpayer “disposes of his entire interest in any passive activity.”67 Under this rule, all the suspended passive losses allocable to the electing taxpayer’s aggregated rental real estate interests cannot be “freed up” until after the taxpayer disposes of substantially all of the interests.68 As a result, if a taxpayer has suspended passive losses allocable to multiple properties that are likely to be sold in the near future, it is sensible for a tax controversy professional to advise the taxpayer to defer making the aggregation election until after the sales are completed (or to revoke an otherwise effective election).

IV. Taxpayer Qualifies as a Real Estate Professional

A. Factors Considered to Qualify as a Real Estate Professional

When determining whether a taxpayer can avoid the passive activity loss rules by using the exception for real estate professionals, courts often consider the taxpayer’s duties and responsibilities with respect to the rental properties. The following duties may help support a finding that the taxpayer materially participated in the rental real estate activity:

• interviewing and performing background checks on new tenants;
• preparing leases and answering questions of new tenants;
• sending or posting eviction notices and initiating eviction proceedings as needed;
• cleaning rental units following tenants’ departures and in furtherance of securing new tenants;
• repairing rental units following tenants’ departure and in furtherance of securing new tenants; changing locks and related security issues;
• purchasing supplies, paint, and repair items for each rental unit;
• repairs of rental properties for existing tenants and in preparation of new tenants;
• maintenance of common grounds, parking areas, and doors for units;
• meeting, communicating, and supervising contractors, agents, and agencies;
• coordinating landscaping with hired landscaper/gardener;
• inspecting grounds and maintaining grounds on a weekly basis;
• bookkeeping, accounting, and banking activities with respect to the rental properties;
• payment of costs and expenses with respect to each of the rental properties;
• coordinating filings and bookkeeping with professionals, including accountants and attorneys; and
• collecting and depositing rent.69

This list of factors is not intended to be exhaustive; however, it can give tax practitioners a good idea of what to look for when faced with the issue of trying to prove a client’s qualification for real estate professional status.

B. Recent Cases

Taxpayers with corroborative documentary evidence have succeeded in litigating real estate professional cases. For example, in the non-precedential Brown v. Commissioner, the Tax Court ruled in favor of the taxpayer and held that the taxpayer’s losses from rental activities were not passive.70 The taxpayer in this case resided on the first floor of a three-unit multi-family house and rented out the remaining floors.71 In 2010 alone, the taxpayer spent 1,284 hours — 1,008 of which were ultimately allowed — “working on” the property.72 In 2011, the taxpayer spent 1,082 hours — 752 of which were ultimately allowed — “working on” the property.73 A takeaway from this case74 is that the taxpayer kept contemporaneous logs of the hours worked in relation to the property which was instrumental in the Court holding that the rental activities were not passive for the years at issue.75 This case also offers some lessons on how to properly document records for current real estate professionals. With regard to the total hours logged each year, some hours were disqualified for two reasons: (1) the taxpayer counted hours attributable to her own unit and (2) the taxpayer counted hours attributable to common spaces without pro-rating the hours (one-third of the time spent on the common areas to her family’s residence was removed).76 Even after removing that time, the taxpayer was held to have materially participated in the rental real estate activity because she met the more–than–500–hour requirement of Treas. Reg. § 1.469–5T(a)(1) for both of the years at issue.77

Similarly, in Leyh v. Commissioner, which is also non-precedential, the Tax Court recently held that the taxpayers were entitled to apply losses from the real estate activity against their nonpassive income.78 The focal point of the controversy in this case was whether one taxpayer’s revised log was sufficient to show that she met the 750-hour requirement of section 469(c)(7).79 The record reflected that the taxpayer kept a contemporaneous log and activity.80 The total hours originally recorded on the log, however, did not account for the total amount of travel time.81 Accordingly, the taxpayer identified those days and added them in to meet the threshold 750-hour requirement.82 The Service, however, contended that the times on the original log were inclusive of all of travel activity, and cited other precedent where there was inadequate records and evidence to meet the 750-hour requirement.83 The Court held that the taxpayer’s original log and her revised log were well within the guidelines of Treas. Reg. § 1.469–5T(f)(4).84 The Court reasoned that the cases that the Service cited did not involve a contemporaneous log as in this case, and that the taxpayer was very specific in her explanations.85 Thus, Leyh v. Commissioner stands for the proposition that the reliability of the records relied upon to establish real estate professional status can be as important (if not more so) than the contemporaneousness of those records.86

C. Airbnb – Can a Temporary Landlord Be a Real Estate Professional for Tax Purposes?

One can expect litigation in this area to persist as temporary landlords offer to rent their homes on popularized apps that offer an alternative to the traditional hotel. Launched in 2008, Airbnb is a popular app where people list, find, and rent lodging. Most people who use this app to rent properties may not consider the potential tax consequences or that there are limitations that may apply to their rental losses.

This area of the law is fraught with technicalities that can be troubling to temporary landlords. An issue which is outside the scope of this article, for example, is Section 280A. That section disallows otherwise allowable deductions with respect to a dwelling unit used as a taxpayer’s residence. Section 280A(d)(1) provides that a taxpayer is considered to have used a dwelling unit as a residence where the property is used for personal purposes for a time which exceeds the greater of 14 days or 10% of the number of days during which the property is rented at a fair rent. Thus, while temporary landlords may want to claim a loss with respect to their temporary rental properties, if they used the rental property as a dwelling unit as a resident, these deductions may be altogether disallowed (never even implicating the passive activity loss limitation rules of Section 469).

This demonstrates how the real estate professional rules can effect and create tax consequences for sporadic landlords who have been opened up to the rental market from fairly new technology, such as the Airbnb app.

V. Recommendations for Volunteers Assisting Pro Se Litigants

Avoiding the passive activity loss rules using the exception for real estate professionals ultimately is a challenging exercise for tax controversy professionals, let alone the pro se taxpayer, as the Service’s determinations in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving by a preponderance of the evidence that the determination is improper.87

The facts surrounding many recent tax court decisions demonstrate the issues pro se taxpayers can encounter. For example, in Oderio v. Commissioner, the taxpayer was a pro se petitioner who claimed she was entitled to a rental loss deduction for 2008.88 The taxpayer conceded that she did not separately satisfy the requirements of section 469(c)(7)(B); however, she argued that her spouse does, and therefore she satisfies them, too.89 The Court examined the language in the relevant Temporary Treasury Regulations and determined that while the Regulations that the taxpayer cited do allow for spousal attribution with respect to the material participation requirements of section 469(c)(7)(B), they do not, as she contended, allow for spousal attribution for purposes of meeting its other requirements, namely, that a taxpayer perform more than one half of his or her personal services and more than 750 hours in real estate trades or businesses in cases where a joint return is not filed.90

In addition, in Almquist vs. Commissioner, a pro se taxpayer provided the Court with self-serving testimony, but did not provide any of the purported supporting documentation, logs, or emails.91 The Court again ruled against the pro se litigant citing the petitioner’s testimony as being nothing more than “a post event ‘ballpark guesstimate.’”92

Moreover, in Flores v Commissioner, the pro se taxpayer even testified that his entries indicating that he spent four hours doing bookkeeping were inaccurate.93

In contrast, in Fitch v. Commissioner, when determining whether the taxpayers (who were represented by counsel) were entitled to deduct rental real estate losses for the property in question, and whether these and other rental real estate losses are limited by the passive activity loss rules of section 469, the Court solely relied upon the credibility of the taxpayer testimony.94 One taxpayer testified extensively as to the activities he performed with respect to his rental properties, and the Court held that the taxpayer qualified as a real estate professional and satisfied the second enumerated test for material participation.95 Surprisingly, the Court made no reference to any evidence presented, and the Respondent unsuccessfully argued that the court should disregard the taxpayers’ testimony as self-serving.96

Tax controversy professionals assisting self represented taxpayers at calendar calls should understand the errors pro se taxpayers made in cases such as Oderio, Almquist, and Flores in seeking achieve the same result as the petitioners in Fitch. For instance, Oderio serves as a good example of a pro se taxpayer misinterpreting and misusing the language of a statute (which seemed on its face would work to her benefit), leading to a ruling against her.

VI. Conclusion

Taxpayers who attempt to avoid the passive activity loss rules using the exception for real estate professionals can present a challenge for tax controversy professionals. The IRS and Tax Court have been very skeptical of taxpayers who have presented testimony and documentation that is not nearly “spot-on” when it comes to satisfying the “more than half” and 750 hour tests of section 469. As a result, tax controversy professionals are encouraged to advise their clients to keep contemporaneous documentation of time they claim they spent, and to prepare their clients in advance of providing testimony so that it is consistent with documentation they are providing to the Court. Ensuring reasonable and reliable documentary evidence is the best medicine for being successful on a real estate professional issue.

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This post was written by Patrick Binakis