Real Estate Professional {Sec. 469(c)} - A Win For The Taxpayer

William Delaney, EA
Westwood, MA

Taxpayers Roberta and William Birdsong claimed that real property rental losses were fully deductible (and not subject to the passive activity loss limitation of $25,000) because Roberta qualified as a real estate professional and met the requirements of Sec. 469(c) as to material participation, and at least 750 hours of services performed.

Under Temporary Reg. 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 report, logs, or similar documents are not required if the extent of such participation may be established by other reasonable means.  Reasonable means for purposes of this paragraph 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 periods, based on appointment books, calendars, or narrative summaries.”  (emphasis added)

In Roberta Birdsong and William H. Birdsong v. Comm. of Internal Revenue, T.C. Memo 2018-148 (9/10/2018), the IRS conceded that Roberta satisfied the material participation requirements of Sec. 469(c)(7)(B)(i) “because she was not otherwise employed in 2014.”  However, the IRS asserted that Roberta had not satisfied the 750 hour test under Sec. 469(c)(7)*B)(ii) because the logs presented “were not contemporaneous and contained inaccuracies.”  The Court disagreed---see below.

William is employed full-time as an emergency physician.  Roberta divides her time between “caring for their children and managing their rental properties.  The rental properties consisted of one five unit building and another four unit building.  Roberta introduced two spreadsheets – the first documents 844.75 hours managing rental properties in 2014; the second documents 1,136.25 hours for the same period.  The second adds “previously omitted tasks such as investor hours and driving time between the rental properties and…locations pertinent to the management of the units.”

Taxpayers used Roberta’s calendar and receipts to reconstruct time for the first half of 2014.  For the second half, a contemporaneous, detailed, phone log was used, together with receipts and invoices to support the entries.

“Petitioners testified credibly and in detail about petitioner wife’s activities and extensive management of their rental properties…We find petitioners’ narrative summary and thorough time logs convincing because petitioners owned numerous rental units that petitioner wife operated alone.”  Referencing Hailstock v. Commissioner , TC Memo 2016-146, “Although we caution petitioners wife to construct more strictly contemporaneous time logs for her future endeavors, we find her credible testimony and time logs to be a “reasonable means” of proof.  (emphasis added)

What to take from this Case.  It is important that satisfactory evidence which meet the test of material participation and 750 hours be maintained.  In this Case, the taxpayers also elected to treat both rental properties as one for purposes of the 750 hour rule.  While they easily met the requirement of the temporary regulation, the IRS auditor did not place great weight on the regulation and asserted that contemporaneous records were not maintained (even though they are not a requirement if other reasonable means will serve the same purpose.

Now that we have the new Sec. 199A pass-through deduction in place, it is important to note that this type of taxpayer will meet the trade or business definition of a pass-through entity (although a loss will be suspended and not pass-through).  It is the only non-Schedule C filer which meets the definition.