All Forum Posts by: Bruce D. Kowal

Spend some time educating yourself in real estate taxation.  Take courses offered to CPA's by State Societies.  If those courses are now in-person, so much the better.  You can talk with professionals there.  For something as important this, you cannot delegate 100%.  Read professional literature on this, such the excellent online version of The Tax Adviser.  Read  CPA blogs on taxation, look for real estate topics.  Reddit has some good blogs.  Generally, I don't want to review someone else's work - unless you make me an irresistible offer.

 The hours must be reasonable, and you must be credible.

Start here:  https://apps.dos.ny.gov/public...

You know there is a reason they try to hide their ownership, right?

Try to find the attorney who did the filing, and get in touch with him/her.

IRS will challenge the 750-hour requirement under §469(c)(7)(B)(ii).   The Temp Regs set forth the requirements to establish hours of participation §1.469-5T(f)(4):  

"The extent of an individual's participation in an activity may be established by any reasonable means.  Contemporaneous daily time reports, logs, or similar document are not required if the extent of such participation may be established by other reasonable means.  Reasonable  means  . . .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."

Fine.  How does this work out in an IRS audit?  Fortunately in a Tax Court case from 2018, IRS challenged Roberta Birdsong's 750 hours [Birdsong v.  CIR, T.C. Memo 2018-148  https://www.courtlistener.com/...].  She won her case.  

This is how her record keeping was characterized. This is worth reading.

"[She] was the sole party actively involved in the day-to-day management of their rental properties.  These tasks included, inter alia, cleaning common areas, collecting coins from washing machines, performing repairs at their properties, communicating with tenants, collecting and depositing rent, maintaining insurance policies purchasing materials for the properties as needed, paying bills and keeping book and records for tax accounting purposes.  She occasionally hired a contractor (such as handyman or plumber) to perform tasks she could not complete herself.  When she hired a contractor . . .[she] spent considerable time researching and contacting contractors, obtaining price quotes, and supervising repairs.  [Her] management duties also included inspecting units, preparing (painting and supervising contractors) units for rental, advertising vacant units, screening potential tenants, showing the units, and processing rental applications."

Good grief!  She was busy.  And what kind of record keeping system satisfied the Tax Court Judge?

"[She] produced two spreadsheets detailing her rental management activities.  The first spreadsheet reflects that [she] logged 844.75 hours managing the rental properties . . .  The second spreadsheet includes previously omitted tasks such as investor hours and driving time between rental properties and the hardware store and other locations pertinent to the management of the units.  [She] used her calendar and receipts to reconstruct the time entries on both spreadsheet for the first half of 2014.  For the second half of 2014, the time entries come from a contemporaneous log [she] maintained on her phone on which she entered the date, location, time, and description of each task she performed.  [She] wife receipts and invoices that substantiate the hours she logged."

At the hearing in the US Tax Court, Mrs. Birdsong represented herself.  She did not use a tax lawyer.  This is called "Pro Se".  Likely, she was well coached by the CPA who prepared her tax return.  What did the Judge think of her testimony?

"[She] testified credibly and in detail about [her] active and extensive management of the rental properties.  [Footnote 5:  We find [her] to be honest, forthright, and credible]. Furthermore, [she] presented detailed spreadsheets that reflected [her] rental management activities exceeded the 750-hour requirement.  We find [her] narrative summary and thorough time logs convincing because [she] owned numerous rental units that she operated alone.  [Her] testimony is further buttressed by [her] thorough time-keeping as well as the receipts and invoices [she] produced to corroborate her time logs."

Is there a lesson here?  Sure. It's obvious.  Keep detailed contemporaneous logs of time and expenses.  Work with a competent CPA to oversee this during the year.

As for 2022, yes, five months have elapsed, but it's not too late to reconstruct a log from January and get on the straight and narrow path to defending your Real Estate Professional status in 2022.  Consult your CPA about this.  Always assume you will be audited, and you will prevail.

This is the type of information you should expect to find on Bigger Pockets.  Right?

[If you found this to be useful, don't forget to give me a thumbs up!]

Start with the mortgage company. What kind of ownership structures can be used. The mortgage company is the tail wagging the dog. Consult with a real estate attorney about fractional ownership. You may be precluded from deferring gain on sale under §1031 if the structure is an LLC. Maybe speak with a Qualified Intermediary now, before you set up the structure. In other words, let the mortgage company give you a range of ownership structures, and run that by a QI.

IRS is not shy about disputing claims to Real Estate Professional status.  It's an easy desk audit for IRS.  They query Schedule E losses.  And if IRS challenges your claim to be a Real Estate Professional they will slap on a 20% negligence penalty. §6662(a) and (b)(2).  

So, can you at least blame the tax preparer?  You know, tell IRS that you relied upon the advice of a professional?  Possibly.  You have to demonstrate that you acted with reasonable cause and in good faith.

OK. So what are the requirements?

1]  You must show that the Adviser [the person who prepared your return] had sufficient expertise to justify that reliance

2] the taxpayer provided necessary and accurate information to the adviser, and

3] that the taxpayer actually relied in good faith on the Adviser's judgment.

What does this mean in the real world?

You should get a written Opinion from the Adviser wherein he is able to list all the facts and circumstances, and apply the Tax Law to those.  That's it, really.  

In the case of REP status, the Adviser should be well grounded in IRC §469(c)(7) and IRC Reg. §1.469-5T et seq.  as well as recent case law [this is very important].  The Opinion is what protects you from the 20% penalty.  [actually the penalty could be 10% if the dollar amount of the understatement is low enough. But this is unlikely when disallowing your deductions]

So, if IRS prevails in its dispute with you, at least you will save on penalties.  

What is the cost-benefit of getting an Opinion?  Well if you took $30,000 in losses, which IRS later disallowed, you may owe $10,000.  And the penalty on that is $2,000.  That's an idea of the benefit.  The penalty you could avoid.

What is the cost?  It depends.  I would charge between $1,000 and $2,000 for such a letter with simple facts and circumstances.  More complex, more billable hours. Could be much higher.  

Is it worth it to seek advice from a competent tax adviser?  Like most things in life, you get what you pay for.  And all readers of Bigger Pockets who have to deal with professionals of all stripes have learned that lesson in spades.

And, not to state the obvious, my advice here is my opinion.  Nothing less and nothing more.

You do realize that you represent less than one half of one percent of Americans.  Enjoy

No one asked me, but with that savings, you should consider medical school.  

If it is done incorrectly, there is penalty and interest.   Weight the full consequences before you complain about a CPA's fees.

Whatever gives you an advantage in dealing with Customers.  Here in the Metro New York area, lots of people with Middle Eastern accents go by Mike, as in the name of the Prophet.  Make it easy.  "Sophie" is fine,  So is "Sally" or "Sue".   Chinese people rarely us their three syllable name, right?