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Failure to File Joint Return Precludes Rental Loss Deductions.
(Parker Tax Publishing March 29, 2014)

The passive activity loss rules of Code Sec. 469, as many practitioners know first hand, are not the model of clarity. The regulations under Code Sec. 469 include final regulations, temporary regulations, and proposed regulations, some of which are 20 years old. Included in those regulations is a spousal attribution rule that allows one spouse's material participation to be attributed to the other spouse in determining whether an individual has materially participated in an activity that produces passive income, such as a rental real estate activity. However, as one taxpayer recently found out, to fully take advantage of this rule, a joint return must filed. In Oderio v. Comm'r, T.C. Memo. 2014-39 (3/10/14), a landlord was precluded from deducting rental losses because she did not file a joint return with her husband. The Tax Court's decision is instructive in that it clarifies the interaction of various regulations that dictate how the spousal attribution rules under Code Sec. 469 are applied.

Facts

During 2008, Julie Oderio was married to and lived with Jason Oderio. Julie worked full time as an employee for RREEF, a real estate investment company. Also in 2008, Julie owned rental property in San Jose, California. For 2008, Julie filed her tax return as married filing separately. On that return, she deducted almost $30,000 in rental losses with respect to her rental property. The IRS disallowed the deduction.

Rules for Deducting Rental Losses

Under Code Sec. 469, taxpayers cannot generally deduct passive activity losses. A passive activity loss is defined as the excess of the aggregate losses from all passive activities for the year over the aggregate income from all passive activities for the year. A passive activity is any trade or business in which the taxpayer does not materially participate.

Under Code Sec. 469(c)(2), rental activities are generally treated as per se passive, regardless of whether the taxpayer materially participates. However, Code Sec. 469(c)(7)(B) provides an exception for real estate professionals. To qualify, a taxpayer must meet two requirements: (1) more than one-half of the personal services performed in trades or businesses by the taxpayer during the tax year are performed in real property trades or businesses in which the taxpayer materially participates, and (2) the taxpayer performs more than 750 hours of services during the tax year in real property trades or businesses in which the taxpayer materially participates. The flush language of Code Sec. 469(c)(7)(B) provides that, in the case of a joint return, these requirements are satisfied if and only if either spouse separately satisfies the requirements. For purposes of this provision, Code Sec. 469(c)(7)(B) provides that activities in which a spouse materially participates are determined under Code Sec. 469(h). Code Sec. 469(h), in turn, provides that in determining whether a taxpayer materially participates, the participation of the spouse of the taxpayer is taken into account. However, this is not the only provision where spousal attribution is mentioned.

Reg. Sec. 1.469-9, titled "Rules for certain rental real estate activities," provides guidance to taxpayers engaged in certain real property trades or businesses on how to apply the exception in Code Sec. 469(c)(7) to their rental real estate activities.

Reg. Sec. 1.469-9(c)(4) provides that spouses filing a joint return are qualifying taxpayers only if one spouse separately satisfies both requirements of Code Sec. 469(c)(7)(B). The regulation further provides that, "in determining the real property trades or businesses in which a married taxpayer materially participates (but not for any other purpose under this paragraph (c)), work performed by the taxpayer's spouse in a trade or business is treated as work performed by the taxpayer under Reg. Sec. 1.469-5T(f)(3), regardless of whether the spouses file a joint return for the year."

Reg. Sec. 1.469-5T(f)(3) treats the participation of a taxpayer's spouse in an activity as participation by the taxpayer for purposes of Code Sec. 469 and its regulations without regard to whether the spouses file a joint return.

Taxpayer's Argument

Julie admitted that she did not separately satisfy the requirements of Code Sec. 469(c)(7)(B) for determining whether she materially participated in her rental real estate activity. However, she argued that her husband, Jason, did satisfy those requirements and, therefore, she satisfied them also by virtue of the spousal attribution rule. In making this argument, Julie relied on Reg. Sec. 1.469-9(c)(4) and Reg. Sec. 1.469-5T(f)(3). She contended that, under those regulations, Jason's efforts were attributable to her for purposes of satisfying the material participation requirements of Code Sec. 469(c)(7)(B), regardless of whether she and Jason filed a joint return.

OBSERVATION: The facts in the court decision did not describe Jason's activities with respect to the rental real estate.

IRS's Argument

The IRS argued that because Julie did not file a joint return with her husband, she did not satisfy the Code Sec. 469(c)(7)(B) requirements through her husband and must separately satisfy them herself.

The Tax Court's Analysis

The Tax Court sided with the IRS and held that Julie could not deduct her rental real estate losses because she did not file a joint return. According to the court, she could not satisfy the Code Sec. 469(c)(7)(B) requirements through her husband and instead had to separately satisfy them herself.

With respect to Julie's arguments, the court noted that Reg. Sec. 1.469-5T(f)(3) treats the participation of a taxpayer's spouse in an activity as participation by the taxpayer for purposes of Code Sec. 469 and its regulations without regard to whether the spouses file a joint return. However, the court observed, Reg. Sec. 1.469-9(c)(4) clarifies the scope of attribution as it relates to satisfying the requirements of Code Sec. 469(c)(7)(B) and provides, in pertinent part, that spouses filing a joint return are qualifying taxpayers only if one spouse separately satisfies both requirements of Code Sec. 469(c)(7)(B).

The Tax Court said that, in determining the real property trades or businesses in which a married taxpayer materially participates (but not for any other purpose), work performed by the taxpayer's spouse in a trade or business is treated as work performed by the taxpayer, regardless of whether the spouses file a joint return for the year. The rental real estate activity of a "qualifying taxpayer" under Reg. Sec. 1.469-9, the court stated, is exempt from per se passive activity loss treatment. According to the court, the parenthetical "(but not for any other purpose under this paragraph(c))" limits the use of spousal attribution under Reg. Sec. 1.469-5T(f)(3), for purposes of satisfying the Code Sec. 469(c)(7)(B) requirements, to the material participation requirements of that section.

In conclusion, the court stated that, while the regulations Julie cited do allow for spousal attribution with respect to the material participation requirements of Code Sec. 469(c)(7)(B), they do not allow for spousal attribution for purposes of meeting its other requirements, namely, that a taxpayer perform more than one half of his or her personal services and more than 750 hours in real estate trades or businesses. (Staff Editor Parker Tax Publishing)

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Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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