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Tax Court: Travel Time Puts Taxpayer Over the Top for Real Estate Professional Status.

(Parker Tax Publishing April 28, 2015)

The Tax Court held that a taxpayer's revised log detailing the time she spent traveling to her rental properties could be used to prove she satisfied the 750-hour material participation requirements for real estate professionals. Leyh v. Comm'r, T.C. Summary 2015-27.

Background

Richard Leyh and Ellen O'Neill resided on a ranch in Dripping Springs, Texas and owned twelve rental properties in Austin, Texas. Eleven of the rentals were single family residences and one was a condominium unit. O'Neill worked regularly in the rental real estate activity. She performed some of the repairs and most of the maintenance on the properties, and handled advertising for, interviewing, and vetting of potential tenants. She also did all of the paperwork, bookkeeping, and research for potential properties to purchase. O'Neill maintained a contemporaneous log detailing the time spent on the various activities.

The taxpayers' residence was approximately 30 miles from the rental properties and O'Neill regularly drove to the Austin area to resolve problems, perform maintenance, and administer and operate the properties. The drive took an average of 50 minutes, and O'Neill kept a meticulous record of her daily activities.

On their joint 2010 tax return, Leyh and O'Neill deducted a $69,531 loss stemming from the rental real estate activity to reduce their non-passive-activity income. When the IRS examined the return, and the taxpayers offered O'Neill's log to support her deductions for real estate losses from their non-passive-activity income. Although the log detailed the dates, types of activity, and number of hours that O'Neill spent managing the rental properties, the number of hours spent traveling to the properties had not been included. As a result, she fell short of the 750 hour material participation requirement under Code Sec. 469. O'Neill revised and resubmitted the log to reflect the hours she spent traveling to the properties, but the IRS refused to accept the additional hours and disallowed the claimed deductions for real estate losses.

Analysis

Under Code Sec. 469, taxpayers are generally precluded from deducting passive activity losses, including rental activity, which is usually treated as a passive activity. Code Sec. 469(c)(7) provides an exception where the taxpayer is a real estate professional. A taxpayer qualifies as a real estate professional if:

(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 service during the tax year in real property trades or businesses in which the taxpayer materially participates (Code Sec. 469(c)(7)(B)).

The extent of an individual's participation in an activity may be established by any reasonable means, which may include the identification of services performed over a period of time and the approximate number of hours spent performing such services during such period, based on appointment books, calendars, or narrative summaries (Reg. Sec. 1.469-5T(f)(4)).

The IRS argued that O'Neill did not meet the 750-hour test because the original log only reflected 632.5 hours spent on rental real estate activity, and further, her revised log was insufficient to remedy the shortfall. In denying O'Neill's revised log, the IRS relied on several prior Tax Court cases where inadequate recordkeeping and insufficient evidence failed to support the threshold hour requirement (Bailey v. Comm'r, T.C. Memo. 2001-296; Speer v. Comm'r, T.C. Memo. 1996-323; Goshorn v. Comm'r, T.C. Memo. 1993-578). In those cases, the Tax Court recognized that the recordkeeping requirements of the Code Sec. 469 regulations, while somewhat ambiguous, do not allow a postevent "ballpark guesstimate."

The Tax Court concluded that the cases the IRS relied on were inapplicable, however, because they did not involve a detailed contemporaneous log such as the one that O'Neill maintained. The court noted that O'Neill was aware of the record keeping requirements for deducting real estate losses, since she had been audited in the past, and found she provided detailed, accurate day-by-day explanations of the specific rental real estate activity in her log. Although the total hours originally recorded on the log did not reflect her travel time from her Dripping Springs home to Austin, the court determined that her revised log adequately accounted for the time.

The court noted that O'Neill's methodology in revising the log was to compute a 45-minute trip, or 1-1/2 hours round trip, for each day the log reflected the activity took place in Austin. Given O'Neill's detailed records in the original log, the court found it was easy to identify days when the activity took place in Austin, and determined the account of her travel time was reasonable, and could be used to establish that she met the 750-hour test. The court found that by including the travel time, taxpayer's hours totaled 846, exceeding the 750-hour threshold by almost 100 hours.

OBSERVATION: The Tax Court did not share its reasoning for treating the taxpayer's local travel time between Dripping Springs and Austin as time spent on the rental activity rather than as personal commuting time. The regulations do not address the treatment of travel time, and the Tax Court has been less kind to taxpayers in previous decisions involving the use of travel time toward material participation requirements (see, e.g., Mowafi v. Comm'r, T.C. Memo. 2001-111 and Truskowsky v. Comm'r, T.C. Summary 2003-130).

Because O'Neill's revised log was a reasonable and credible means to prove that she met the 750 hour threshold for real estate professionals to deduct real estate losses, the Court held that, contrary to the IRS's objections, the logbook satisfied the requirements of Reg. Sec. 1.469-5T(f)(4), and allowed O'Neill's claimed deductions.

For a discussion of the deductibility of rental losses, see Parker Tax ¶ 247,105. (Staff Editor Parker Tax Publishing)

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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