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Don't want to be passive? Track your time.

December 01, 2009

The passive loss rules restrict losses from most businesses unless a taxpayer "materially participates." Rental real estate losses are always passive unless the taxpayer is a "real estate professional," who spends at least 750 hours, and more than half of his or her working hours, working in real estate.

A couple with Massachussetts real estate learned the hard way that the courts won't take your word for how much time you work on your real estate:

Mr. Kibiro testified that he and his wife did not keep "meticulous records" regarding the rental properties, and petitioners produced no such records at trial. Although Mrs. Njoroge testified that she traveled to the Springfield property two or three times a week, there is no indication of the number of hours she spent working on the rental properties. Consequently, petitioners have not established that they meet the requirements of either section 469(c)(7)(B)(i) or (ii). Because petitioners have failed to establish that either spouse qualifies as a real estate professional under section 469(C)(7)(B), their rental real estate activity is per se passive under section 469(c)(2)

If it's not your full-time job, you really need to track your time on your business. Keep a daily calendar of your time, and don't put it together the day the IRS agent comes to audit you.

Cite: Njoroge, T.C. Summ. Op. 2009-177

MATERIAL PARTICIPATION BASICS

The regulations say you achieve "material participation" in non-real estate activities for a tax year if:

-You participate at least 500 hours; or
-You participate at least 100 hours and at least 500 hours in that and other "100 hour" activities; or
-You participate at least 100 hours and more than anybody else, or
-You are the only participant; or
-You materially participated in five of the past ten years )or in any three years for a service activity).

There is also a "facts and circumstances" test, but don't count on it.

A special rule apples to real estate. If you are not a "real estate professional," losses are normally passive no matter what, unless you provide "extraordinary" personal services.

If you are a "real estate" professional," you can apply the normal material participation rules to determine whether you have a passive activity. To be a real estate professional, you have to spend at least half your working hours - not less than 750 hours annually - in "real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade."

Tags: passive losses.real estate professional.