If you have a day job that's not in the real estate business, it's hard to qualify for the "real estate professional" loophole in the "passive loss" rules. The tax law treats losses from rental real estate activity as automatically "passive" if you don't qualify, and those losses are only deductible if you have "passive" income. If you are a real estate pro, you can deduct real estate losses if you meet the passive loss "material participation" rules that apply to all taxpayers for non-real estate losses.
To qualify as a real estate pro, you have to pass two tests:
- You have to spend at least 750 hours on your real estate activity, and
- You have to spend more time in your real estate business than you do on any other job you have.
The second test is usually impossible to pass if you have a non-real estate day job. But it can happen, as the Tax Court showed yesterday. The taxpayer husband, Mr. Miller, had a day job as a harbor pilot in San Francisco. He also had rental real estate property that Mrs. Miller helped him operate. Fortunately, piloting, while a skilled profession, seems to not be all that time-consuming:
At the age of 29, Mr. Miller became a partner in the San Francisco Bar Pilots Association (SFBPA) and began piloting commercial seagoing vessels for SFBPA.4 During the years at issue, Mr. Miller piloted client vessels for the SFBPA, including large container ships, passenger cruise ships and large military ships. He piloted these client vessels from 13 miles at sea, outside the San Francisco Bay Channel, throughout the San Francisco, San Pablo and Suisun Bays, including the Sacramento and San Joaquin Rivers.
Mr. Miller's schedule as an SFBPA pilot requires that he work seven days and then have seven days off. Mr. Miller generally is not required to actually work for all of his seven days "on." His schedule is also somewhat flexible and predictable. SFBPA pilots know roughly when they will have to work during their "on" time and can trade turns in the pilot rotation, subject to limitations.
That enabled him to throw himself into his real estate projects, and throw himself he did:
In addition to Mr. Bogart, other witnesses described Mr. Miller's work ethic as extraordinary. A friend, pilot and partner of Mr. Miller's at SFBPA testified to his "one in a million" work ethic, saying that he did not know anyone who worked harder. Mrs. Miller testified that she had to go to Mr. Miller's construction sites to see her husband.
Wisely, Mr. Miller maintained records of his time, and he convinced the Tax Court that he met both the 750-hour and more-than-other-job requirements:
Mr. Miller completed a number of significant construction projects, both as a contractor and as a landlord, in the years at issue. He also performed a number of additional real estate tasks including researching properties, bidding on properties, finding tenants, collecting rent and performing maintenance work at rental properties. Mr. Miller presented contemporaneous work logs for his construction and rental activities and provided compelling testimony and witnesses. Thus, we find that Mr. Miller is a qualified real estate professional within the meaning of section 469(c)(7)(B).
But being a real estate pro is only the first step. Mr. Miller had to prove he "materially participated" in the loss activities. Mr. Miller passed that test for two of the activities, but not for four others:
Bennett Valley property for over 100 hours per year for the relevant years.10 We are also satisfied that their participation was not less than the participation of any other individual for those years. It follows, and we hold, that petitioners materially participated in the rental real estate activities at the Pepper Road property and the Bennett Valley property in the relevant years and the deductions attributable to those activities are not subject to limitation under section 469.
Petitioners have not shown, however, that they participated in the rental real estate activities at the Morning Glory property, the Lind property, the Price property or the Emerald property for over 100 hours per year for the relevant years.
The Moral: If you're day job isn't in real estate brokerage or development, you need a day job that isn't very time consuming to qualify as a real estate professional. Then you have to work your butt off on your real estate work, and keep good records of your time.
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.
The items included in the Tax Update Blog are informational only and are not meant as tax advice. Consult with your tax advisor to determine how any item applies to your situation.
Joe Kristan writes the Tax Update items, and any opinions expressed or implied are not necessarily shared by anyone else at Roth & Company, P.C. Address questions or comments on Tax Updates to