Charles Kim wants to ask a BP CPA a question.

12 Replies

Charles Kim owns two S Corps: Kim's Tae Kwon Do Inc. and Kim's Brokers Inc. in 2012, he W2ed himself $30k for both corporations. He has two 4th degree black belt instructors working for him and has a K1 of $70,000. He sold 10 homes and has a K1 of $70,000 in his real estate brokerage business. He owns 3 rental properties in Chinos Hills and 3 rentals in Moreno Valley for a total of 6 homes. In the entire year of 2012, he worked 60% as a real estate agent and 40% teaching martial arts at his Tae Kwon Do School in 2012.

Question for the BP CPA:

1. If 6 of his rental properties are valued $300,000 each. He is allowed a depreciation of $17,000 for each of his rental properties. How much of his 2012 income : 2 K1 and 2 W2 will his rental properties shield his taxes assuming he take no other deductions?

2. If his rental losses are greater than $75,000, is Mr. Kim eligible to deduct
the full amount against his $200,000 income: 2K1 and 2W2?

I'm not sure exactly how all that income lands on the 1040. Or what other stuff might be going on between those figures and the final AGI number. But I can tell you that if your AGI is over $150,000, you cannot use ANY of the passive losses to offset other income. None. If your AGI is less than $100,000, you can deduct up to $25,000 in passive losses against other income. AGI in between $100,000 and $150,000 results in a phase out of the $25,000 "special allowance" by $1 for every $2 of AGI over $100,000.

So, if $200,000 is Charles' AGI, he cannot use any of a $75,000 passive loss as an offset against the other income.

Not a CPA. Perhaps one will give a different answer. I can barely make sense of what my CPA puts on my tax forms.

I know that the real estate losses start to phase out from $100,000 and completely gone at $150,000, but what if you are considered a real estate professional? Can't you then have an AGI of $250,000 and deduct more than the $25,000 cap?

The part i am not sure about is this: Charles can spend more than 70% of this time on his brokerage and have less of a profit on his real estate business than his Karate school. Is IRS more interested that Charles makes more sales in his real estate brokerage or the time he records of how much he spent on his real estate business to be considered a real estate professional in the eyes of the IRS.

This is a no brainer if Charles has a full time job as an engineer, but what if he owns two corporations where he allocates 60% of his time in real estate activities?

Steve,
how often have you see on audits in classifying yourself as a real estate professional and taking beyond the $25,000 cap in real estate losses against in your income?

James Park,

I see them very often. I typically have a new one come in the door every month or so; however, I currently have 4 pending that are due to real estate professional status. They better keep a good log and be able to prove how much time they spend in real estate.

-Steven

Steven- If Mr. Kim does ONLY RE and has less than 750 hours total time, he still qualifies for entire loss as a qualified RE investor, correct? Thanks for being our resident tax guy-you know how much I love them....Rich

@Rich Weese ,

No he MUST spend at least 750 in the real estate trade or business.

Real Estate Professional In A Nutshell
Beginning in 1994, a real estate professional may treat rental real estate activities as non-passive if the taxpayer materially participates in the rental activities.[2] The material participation requirement applies separately to each rental activity (unless the taxpayer made a timely election to group all his rentals as a single activity). These rules apply to individual taxpayers and closely held C Corporations. See checksheet and interview questions at end of chapter.
Issues
To qualify as a real estate professional, the taxpayer must spend:
more than 50 percent of his/her time in real estate activities; AND,
more than 750 hours in real estate activities.
A real estate professional must materially participate in each rental activity for the loss to be deductible.[3]

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Passive-Activity-Loss-ATG----Chapter-2,-Rental-Losses

-Steven

Steve,

Do you see a trend of the ones that get audited by the IRS? I think there is fine line of lieing to claim "real estate professional" to evade taxes and those that honestly put in 750 + hours a year in real estate activities.

I think there is a high probability for a full time engineer who deducts $50,000 in real estate losses to get audited when he claims himself as a real estate professional, and the chances are almost 0% of an audit if you are a full time real estate agent who makes a GCI of $250,000 or more and takes advantages of the full depreciation of his 10 rental property to shield his $150,000 AGI.

What about the people in between? Which situation below would most like trigger an audit from the IRS?

1) The full time engineer can have his wife get a real estate license soley to deduct more than $25,000 in real estate losses, while make an AGI of more than $150,000. The wife does not work as a real estate agent

2) The same scenario as #1 however the wife does work as a real estate agent and manages her husband's three rental properties for a total of 750 hours, however she shows sales transaction as a real estate agent.

2) Mr. Kim owns two s corps: a Tae kwon do business (SCorp) & a brokerage (SCorp) where is he is licensed. Honestly works 800 - 1000 hours in his brokerage business and logs his hours and mileage.

If Mr. Kim really puts in 800 hours a year in his brokerage and only generates $30,000 a year from this compared to $400,000 a year in his Tae Kwon Do business. Will this raise a red flag to the IRS if he really put in 800 hours into his brokerage business?

Does the IRS give more credibility to someone who has a real estate license and has a incorporated real estate business (S - Corp) over a unlicensed real estate investor who is not incorporated who claims to spend 750 or more hours on their 5 rental properties?

This is the grey area I am curious to find out what triggers an audit from the IRS for the "real estate professional" status in this grey area.

Originally posted by Steven Hamilton II:
James Park,

I see them very often. I typically have a new one come in the door every month or so; however, I currently have 4 pending that are due to real estate professional status. They better keep a good log and be able to prove how much time they spend in real estate.

-Steven

James Park,

I have seen MANY audits regarding this topic. They seem ever increasing. I have some clients who we have proven to qualify and some who simply could not pull the information together. Often some come to me when it is too late. If you have two properties it will be very hard to justify the time spent.

There is just as much of a chance between them. All three could just as likely be audited. Mr. Kim is most likely due to income and avenues for hiding income.

Before an audit there is no credibility it is simply a computer based analysis.

-Steven

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