losses becoming deductible against all of your other income on your tax return. Also hurting her situation is the fact that Mrs. Gragg did not maintain contemporaneous records of her participation in the rental real estate activities. She attempted to reconstruct these records by providing after-the-fact estimates of the number of hours she participated in her rental real estate activities. Her records consisted of undated notes stating that participation was approximately 100 hours, 200 hours, etc., for various duties involved with managing and maintaining the rental properties. The court interpreted her records as being very vague and ambiguous, and ultimately rejected this evidence on account of the records being unreliable and unsupported by contemporaneous records. THE PASSIVE LOSS RULESAND REAL ESTATE PROFESSIONAL ELECTION At one point in time, taxpayers had the ability to deduct losses from their investments without limitation. This resulted in the creation of tax shelters, often in the form of carefully structured real estate investments, which were widely abused by taxpayers. To eliminate this abuse, Congress enacted the passive activity loss rules in 1986,
the purpose of which was to limit deductions of passive losses to one’s total passive income. Any excess passive losses are carried forward to future years and can be deducted in full in the year the investment is completely disposed of. These rules put in place the requirement for taxpayers to achieve certain levels of participation in their activities in order to qualify for a deduction of such losses. By definition in the Internal Revenue Code, rental real estate is a passive activity. However, in 1993, Congress recognized that certain individuals materially participate in trades or businesses involving real estate, and that it would be unfair for those individuals to limit their rental real estate losses to their total passive income for the year. With that, the real estate professional exception to the general rule was created, and was designed for individuals that clear two hurdles: • More than 50 percent of their personal services performed in trades or businesses during the year are performed in real property trades or businesses in which the taxpayer materially participates, and • The taxpayer performs more than 750 hours of services during the year in real property trades or businesses in which the taxpayer materially participates.
In determining whether you qualify as a real estate
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