As a landlord, it is important to know that the tax code offers certain advantages, but also understand the limitations of those advantages. If you own rental property, the tax code permits you to claim a wide variety of qualifying expenses that offset the income you make from your rental business. As a result, many rental real estate businesses realize losses. The limitation most landlords must face when filing their taxes is that the code defines most of these businesses as “passive activities” and generally does not permit taxpayers to claim the loss in the year it occurred; rather they may only carry the loss forward to offset gains from the rental property in future years.
There are a few ways to escape this passive activity characterization, though. The primary one, as previously discussed here, is if you are a qualifying real estate professional. Documenting one’s status as a real estate professional often requires you to keep detailed records, as Mohammad Hassanipour found out in his battle with the IRS.
Hassanipour owned seven apartment buildings and a rental house in California. The taxpayer claimed several thousand dollars of losses on his 2008 taxes related to his rental property business. The IRS disallowed the rental losses, concluding that the losses were passive activity losses and, as a result, Hassanipour was not entitled to claim them on his 2008 taxes. The taxpayer asserted that he was entitled because he was a qualifying real estate professional.
The US Tax Court, in Hassanipour v. Commissioner, sided with the IRS. The taxpayer’s problems stemmed largely from a lack of convincing documentation supporting his claims. The taxpayer claimed that he only worked 32-35 hours per week at his “day job” as a consultant; however, all his time sheets stated 40 hours of work per week. Furthermore, the court concluded that Hassanipour’s estimates regarding the amount of time he spent on his rentals were vague and inherently improbable. As a result, the court found the taxpayer less than credible, and ruled for the IRS. The Hassanipour decision is an important reminder to taxpayers that, if they intend to claim “real estate professional” status, they should keep careful records regarding such things as the amount of time spent on their rental business, and should avoid the temptation to exaggerate those numbers.
The changing face of the economy has many people seeking income through new, alternate means, including home-based businesses and rental real estate property. These businesses require careful recordkeeping and a detailed knowledge of the tax code to ensure you receive all the benefits the law allows, and avoid the traps that can yield a stiff penalty. To assist you with tax planning for your rental property or other business, contact the tax attorneys at Samuel C. Berger, P.C. and CPAs at S.C. Berger, P.C. We have a proven track record of helping businesses throughout New York and New Jersey ensure they have the plan in place that they need to succeed. To consult our attorneys and CPAs, contact us online or call (201) 587-1500 or (212) 380-8117.
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Deciding Between Purchasing Rental Real Estate or Investing in a REIT, New York & New Jersey Real Estate Lawyer Blog, April 18, 2013
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