This week, Joe Kristan (CPA & Shareholder, Roth & Company (Des Moines, Iowa); Editor, Tax Update Blog) describes a recent Tax Court case in which the judge rejected a taxpayer's attempt to be treated as a real estate professional for passive loss purposes because of his unsubstantiated assertions that he spent 750 hours per year working on real estate activities.
In Tax Court, the seventh “allegedly” proves fatal
Allegedly. That’s a bad word to see when a Tax Court judge is describing your arguments. It turned out badly for a Massachusetts couple in Tax Court.
Like other taxpayers we’ve seen, the couple was trying to convince the court that they had spent enough time on their rental properties to qualify as “real estate professionals.” If they did, they could deduct their rental losses despite the passive loss rules. Unfortunately, it’s a tough hurdle to clear.
Real estate professionals avoid the “per-se passive” rule that makes their rental losses automatically passive and deductible only to the extent of “passive” income. Instead they get to determine whether they are passive using the hours-spent standards that apply to other business activities. To be a real estate pro, you have to pass two tests:
1. You have to spend at least 750 hours during the year working on real estate activities in which you have an ownership interest, and
2. You have to spend more time on the real estate than you do on anything else. This test tends to disqualify people with day jobs outside of real estate.
The Massachusetts couple had the tall task of convincing the judge that they spent 750 hours each managing two property interests while living in Cape Cod: a rental house near Boston, and a 1/18 interest in two family-owned apartment buildings in Cairo, Egypt. They supplied spreadsheets and diaries attempting to prove the time spent to the judge (I shorten their names to Mr. and Mrs. M.” Empahsis is mine.):
To substantiate the hours they devoted to their rental real estate activity, petitioners prepared and provided to the IRS two documents: “Real Estate Professional Hours for 2010 for Mr. & Mrs. M” (Weston spreadsheet) and “2010 material participation hours for the Dokki Property” (Dokki spreadsheet). Both documents were created after 2010, allegedly on the basis of computer entries and a diary that Mrs. M kept.
That’s the first of seven appearances of “allegedly” in the opinion.
The Weston spreadsheet was not prepared contemporaneously, and it is implausible on its face in many respects. Petitioners allegedly paid bills on 26 separate occasions, and each bill paying exercise supposedly lasted at least one hour and often longer. It is implausible that petitioners spent a total of 64 hours paying bills for a single rental property.
They allegedly devoted 105 hours during October through December 2010 to “work on taxes for 2010.” They offered no credible explanation why they would have devoted 105 hours to such tasks before the 2010 tax year ended or why they would each have spent the same number of hours reading IRS instructions and completing tax forms.
For most entries on the spreadsheet each petitioner supposedly devoted the exact same number of hours to the task in question.
Petitioners allegedly attended every meeting with contractors together and spent precisely the same amount of time at each meeting.
Petitioners allegedly double-teamed tasks that could easily have been performed by one person, such as “supervise yard work” and “prepare and mail final 2009 tax package.”
The couple that meets contractors together stays together?
Most entries on the Weston spreadsheet are round-number estimates; many are clearly inflated, and many are duplicative. Each petitioner allegedly spent 102 hours reading or writing emails relating to the Weston property, for a total of 204 hours, and each such exercise supposedly lasted 30 minutes. Each petitioner allegedly spent 36 hours, for a total of 72 hours, meeting with an insurance agent about a change to their homeowners insurance policy.
After a certain number of “allegedly,” it becomes clear that the judge isn’t buying this. They did no better convincing the judge that they put in enough time in Egypt:
We do not believe that he devoted on average more than four hours each day, seven days a week, to a real estate property that yielded him only $8,000 in rental income, while also visiting family, touring the pyramids and Luxor, and otherwise enjoying a vacation.
Decision for IRS.
The Moral? If you don’t have serious real estate holdings, it may be difficult to convince the judge that it takes you 750 hours to take care of them. It’s possible if you keep good daily records of your time. It also helps if you can make it seem plausible, and the couple failed to pass that test.
Cite: Makhlouf v. Commissioner, T.C. Summ. Op. 2017-1 (Jan. 11, 2017)
Here’s the rest of this week’s Tax Roundup:
Monday, January 9, 2017
Ashley Ebeling, Small Business Health Reimbursement Accounts Resurrected For 2017: There are some new twists to the new HRAs. There’s a new limit to annual employer contributions: $4,950 for employee-only coverage and $10,000 for family coverage. Only employers—not employees—can contribute to the accounts. Employees can use the HRA money to pay for insurance premiums or doctors’ bills. Note the warnings in the piece too.
Howard Gleckman, A new look at how current law and proposed reforms tax entrepreneurs (TaxVox)
Jack Townsend, DOJ Swiss Bank Program NPAs Spike the Data for Overall NPAs in 2015. “One open question is whether the Swiss Bank Program will be a template for resolutions of similar behavior in other countries.”
Jason Dinesen, From the Archives: The IRS’s Preparer Directory Will Be Bad News for Enrolled Agents
Jim Maule reminds us Don’t Forget to Sign the Return. “Despite fixing the error and despite paying the tax, the taxpayer was hit with a late filing penalty.”
Joseph Thorndike, Tax History: Social Welfare on the Cheap: Why Obamacare Was Built to Fail (Tax Notes, subscriber link)
Kay Bell, Keeping track of tax deductible miles. “You need to know not just the specific miles for each possibly tax-deductible trip, but also how many overall miles you drive each year, especially when you use the same car for business and personal travel.”
Kristine Tidgren, Make Sure You Understand the Tax Implications of that Equipment “Trade” (Ag Docket). “If a ‘lease’ doesn’t act like a ‘lease,’ the IRS won’t treat it as one for tax purposes.”
Leslie Book, Financial Consultant Fails To Avoid Self-Employment Tax With S Corp Structure (Procedurally Taxing). “The opinion is a red flag for small business taxpayers who may not follow the exact letter of tax advice or for advisors who may not carefully detail all the steps needed to get the appropriate tax result.”
Lew Taishoff, I WON’T MOURN TEFRA. “While cases for years prior to those beginning last Sunday will continue with FPAAs, tax matterers, partner-level and partnership-level adjustments, computationals and deficiency reviewables, I hope that the new partnership regime will simplify the current silt-stirrings swirling around the Glasshouse at 400 Second Street, NW.”
News from the Profession. Impatient CPA Exam Candidates Won’t Be Pleased With the 2017 Score Release Schedule (Caleb Newquist, Going Concern)
Nicole Kaeding, Where Did Americans Move in 2016?
Peter Reilly, Tax Shelter Guru Gets $60 Million IRS Penalty And No Day In Court. A bad hangover from the turn of the (21st) century tax shelter frenzy.
Robert D. Flach comes through with Monday morning Buzz!, covering ground from fraudulent preparers to refund delays.
Roger McEowen, Top Ten Agricultural Law Developments of 2016 (Five Through One). Number 1: “The Election of Donald Trump as President and the Potential Impact on Agricultural and Tax Policy.”
Tax Prof, The IRS Scandal, Day 1339, Day 1340, Day 1341.
TaxGrrrl, Bogus IRS Calls Topped List Of Most Reported Scams In 2016.
Tyler Cowen, Larry Summers on the new Republican tax plan (Marginal Revolution). Quoting Summers
Tuesday, January 10, 2017
Des Moines Register editorial, Iowa should ban traffic cameras, and cities must face that reality.
Gavin Ekins, Full Expensing is the Federal Government’s Best Investment in the U.S. Economy (Tax Policy Blog). “Allowing businesses to expense the full value of capital expenditures, known as full expensing, has a similar effect to the government investing in a nationwide index fund.”
Jack Townsend, Finews Article on Swiss Bank Shenanigans. “Finews is a swiss media outlet. There was a time when Swiss media outlets would not have offered such articles.”
Jason Dinesen, Why Does the IRS Care So Much About Employee vs. Contractor? “The cynical answer would be, there are penalties to be found in auditing the employee vs. contractor issue.”
John Iselin, Measuring big variations in state revenue capacity (TaxVox). “The 50 states, with their unique mix of communities, industries, and other drivers of economic activity, vary dramatically in their ability to raise revenue. This affects how much each state can spend on public services, which means accurately measuring the available pool of taxable resources is an important consideration for policymakers and analysts.”
Kay Bell, Gas taxes pump up the fuel’s 2017 price in 7 states
Lew Taishoff, EUREKA? “The best response to discovery I know of is that of Archimedes, who jumped stark naked out of his Athenian bathtub and ran thus through the streets yelling ‘Eureka!'”
News from the Profession. Being a Great Place to Work During Busy Season Means More Than a Free Slice of Pizza (Rachel Andujar, Going Concern)
Paul Neiffer, FBAR Due Date Automatically Extended to October 15
Robert Wood, Beware IRS Audits Of Offshore Account Filings. “Even if you can explain one failure to comply, repeated failures can morph conduct from inadvertent neglect into reckless or deliberate disregard.”
Roger McEowen, C Corporation Penalty Taxes – Time To Dust-Off and Review? “A more favorable tax climate for C corporations could spawn renewed interest in their formation and usage. But, remember the penalty taxes that can apply.”
Stephen Olsen, Additional Courts Hold Promoter Penalties Not Divisible For Refund Claim (Procedurally Taxing). The case holds that an individual can’t appeal $60 million in penalties without paying the whole amount. Good luck with that. Peter Reilly has also covered the case.
Tax Reform hints? From the opening speech of Iowa House Speaker Linda Upmeyer: As we look to what our work will focus on this session, it is worth noting the energy that has driven our recent elections. Too many feel unheard, unrepresented, or have lost faith in their government’s ability to address their priorities.
TaxProf, The IRS Scandal, Day 1342
Wednesday, January 11, 2017
Alan Cole, A Beginner’s Guide to Trade and Foreign Exchange (Tax Policy Blog)
Andrew Mitchel, PFIC Mark-to-Market Election Charts & Videos. “Today we added 12 new situational charts to andrewmitchel.com dealing with mark-to-market elections for PFICs. We also uploaded 12 new videos to our YouTube channel that briefly discuss each of the new charts.” Another set of wonderful resources from the International Tax Blog.
Ashley Ebeling, Taxpayer Advocate Urges Congress To Reform The IRS And Overhaul The Tax Code
Bad news. You survived. Kansas man with gambling habit sentenced for tax fraud scheme. “After Geisler was contacted by the IRS, his accountant asked him how he thought he would get away with not reporting business income and payroll taxes. Geisler responded ‘I thought I would be dead before they caught on.'” (Hays Post)
Hank Stern, Flatline: Lagniappe (InsureBlog). “And there’s this: many folks only buy ObamaPlans to help pay for a pre-existing condition, especially an acute or catastrophic one: insurance pays for the bulk of services rendered, then no longer needed.” That doesn’t exactly make insurance affordable.
Jim Maule, With Humor, Taxes a Little Less Deadly. “If a person at the Philadelphia International Airport s in Terminals B through F and purchases a soda or other beverage subject to the ‘soda tax,’ the price is increased by the 1.5-cent-per-ounce exaction. But if a person is in Terminal A-West or A-East, the tax does not apply.”
Kay Bell, Where to find your perfect tax preparer. You know, the one who knows everything and charges nothing.
Lew Taishoff, WITH PARTNERS LIKE HIM. “If you’re interested in the details of a blown-up Bialystok that’s been on IRS’ Ten Worst for many years, read Judge Goeke’s surgical dissection.”
News from the Profession. Big 4 Auditors Are Probably Looking Forward to More Amiable PCAOB (Caleb Newquist, Going Concern). Somehow the republic might survive.
Russ Fox, Please Don’t Do This! “Do not email anything containing personally identifiable information such as social security numbers or dates of birth. Of course, if you want to be a victim of identity theft, go right ahead and do so. But don’t say I didn’t warn you.” Amen, Brother Russ. Also it includes a reference to my Twitter feed. Did you know the Tax Update is on Twitter at @joebwan?
Stephen Olsen, USVI – Residing or Vacationing (and What if You Pay Income Tax While only Vacationing) (Procedurally Taxing). “In an effort to bring businesses to the USVI, an economic development program was implemented in USVI, which allows for a reduction of USVI tax on certain USVI residents up to 90% of their income tax. Not sure how much economic development it has spurred, but a lot of rich people began trying to be bona fide USVI residents (or at least claimed they were), and the IRS took exception.”
TaxGrrrl, IRS Chief Talks Tax Season Open, Refund Delays & Trump Transition Team
TaxProf: The IRS Scandal, Day 1343. From today’s link: “Soon after the Lerner scandal, IRS officials bought the system designed to prevent the loss of emails, but then didn’t bother to turn it on. They also broke federal procurement rules in how they bought the system.”
William Gale, Understanding the Republicans’ corporate tax reform proposals (TaxVox)
Thursday, January 12, 2017
Annette Nellen, IRS National Taxpayer Advocate Report Released. “That all four operating divisions chose to illustrate their Future State by showing that they were right and the taxpayer was wrong is concerning, the report says.”
Howard Gleckman, What Delaying Affordable Care Act Repeal Means for Tax Reform (TaxVox)
Jason Dinesen, Glossary: Form K-1. “Form K-1 reports an individual shareholder’s or beneficiary’s share of the entity’s income and deductions for the year.”
Kay Bell, Trump pledges to donate hotel profits from foreign government payments to the U.S. Treasury. Sounds like a cost-accounting nightmare.
Leslie Book, NTA Releases Annual Report (Procedurally Taxing). “Applying her considerable experience with IRS and using insights from those forums, the NTA has attempted to provide a blueprint for best practices that Congress and IRS should keep handy as IRS crawls into the 21st century.”
Lew Taishoff, NO GOOD DEED. “We reject petitioner’s suggestion that an IRS settlement officer has an affirmative duty to check up on a taxpayer who fails to make good on his own promise to submit documentation required to consider a collection alternative.”
Morgan Scarboro, Which States Rely the Most on Federal Aid? (Tax Policy Blog)
News from the Profession. Goodbye Legacy USB Ports, Hello Dongles (Megan Lewczyk, Going Concern)
Robert Wood, Will California Tax Man Let You Move States? “Many would-be former Californians have a hard time distancing themselves from California, and they may not plan on California tax authorities chasing them.”
Roger McEowen, Farm Financial Stress – Debt Restructuring. Chapter 12 is back in fashion.
Tax Justice Blog, State Rundown 1/11: State Legislative Sessions Kick Off Amid Uncertainty
TaxGrrrl, IRS Issues Warning On New Scam Targeting Tax Professionals
TaxProf, The IRS Scandal, Day 1344
Friday, January 13, 2017
Andrew Mitchel, Increases in Private Letter Ruling Fees for 2017. “Taxpayers with gross income greater than $250,000 and less than $1 million will have a 2% increase — from $9,800 to $10,000”
Bryan Camp, Tax Exceptionalism Lives? QinetiQ v. CIR (Procedurally Taxing)
Hank Stern, #ACA_Fail: Laurie Ann’s story (Insureblog) “For all of the sob stories about what may happen under Repeal/Replace, there’s the reality of the very real, very human cost of the ObamaTax’s implementation:”
Joseph Thorndike, Social Welfare on the Cheap: Why Obamacare Was Built to Fail (Tax Analysts Blog). “And as long as we’re parceling out blame, let’s be sure to allot some to Democrats. If the ACA disappears — immediately or in stages, partially or in total, with replacement or without — Democrats will share in that responsibility. After all, they built Obamacare, and from a political standpoint, they built it to fail.”
Kay Bell, Tax filing checklist 2017. A good place to start for doing your 1040.
Kristine Tidgren, Review Those Custom Feeding Endorsements (Ag Docket)
KTIV.com, Gov. Ricketts proposes property & income tax reform during Norfolk visit. “He stresses that the only state around Nebraska that has a higher income tax is Iowa.”
Lew Taishoff, CODE TC 520. “No, this is neither a medical alert nor the latest computer alert that your e-mail has been hacked. This is the computer code IRS puts on your dossier when you file bankruptcy.”
Mike Lipsman, Why state tax revenues have lagged (Des Moines Register)
Nicole Kaeding, A Tax Compromise Offered in Illinois (Tax Policy Blog). “A total rate of 9.5 percent would give Illinois the fourth highest corporate income tax rate in the country, behind only Iowa, Pennsylvania, and Minnesota, and lowers Illinois’s corporate income tax subcomponent score dramatically. Illinois’s corporate income tax structure would fall into the bottom ten of states.”
Paul Neiffer, California Loses Their Appeal in “Swart”. “Without this ruling, any investment in a passive investment that has any operations in California could require you to file an income tax return in the State of California and pay the minimum $800 franchise tax and pay someone like us to prepare the return (which may cost more than $800 since I can tell you the California tax returns are almost more complex than federal returns).”
Peter Reilly, Comprehensive Tax Reform Threatens Supply Of Affordable Rental Housing. I disagree. I think the low income housing tax credit distorts housing markets and favors the political insiders who seem to get first shot at the state credit allocations. Removing zoning restrictions and anti-density rules would do a lot more for housing affordability, especially in ridiculously-regulated markets like California.
Politico, A hit in the pocket. “It’s not a stretch to say that the House GOP’s tax reform plan is counting on a currency adjustment to work.”
Robert D. Flach, WHO MUST FILE A 2016 TAX RETURN? “Do you have to file a 2016 tax return? Let’s review.”
Russ Fox, Swart Wins Appeal; Not Liable for California Minimum Tax. “The bad news is that I fully expect the Franchise Tax Board to appeal this decision to the California Supreme Court. Still, we appear to be reaching the point where California will likely cease this practice.”
Sam Brunson, TurboTax vs. H&R Block: Deductible Moving Expenses and Haunted Houses (Surly Subgroup). Any time those two face off, I grab some popcorn.
Stan Veuger, How border adjustment threatens the education, real estate, and hospitality industries.
Stuart Gibson, The Devil You Know (Tax Analysts Blog)
TaxGrrrl, What’s A Blind Trust, Anyway, And Why Won’t It Work For President-Elect Trump?
TaxProf, The IRS Scandal, Day 1345.
Tyler Cowen, Scott Sumner has some questions on the border tax adjustment. “I agree with Scott’s most general claim that the case for this tax has not yet been made.”