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AuditProof Your Time Spent on Rental Properties

March 2010

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AuditProof Your Time Spent on Rental

Properties

If you claim status as a real estate professional to qualify for deducting your rental property losses, your time record for the year must prove that you spent

1. more than onehalf of your personal service time in real property trades or businesses in which you materially participate, and

2. more than 750 hours of your personal and investor services time in real property trades or businesses in which you materially participate.

If married, either you or your spouse must pass the time tests above individually to qualify as a real estate professional. If one spouse qualifies, both spouses qualify.

Real estate professional status is great, but there is one additional hurdle. To deduct tax losses on a rental, you must prove that you materially participated in the rental activity. If married, husband and wife may count their joint efforts toward passing the material participation tests.

Most of the tests for material participation are based on hours worked, as explained in the article titled "How to Materially Participate to Deduct Rental Property Tax Losses."

What IRS Regulations Say

The IRS says that you can establish your participation in an activity by any reasonable means.1

Beware of this upcoming sentence. The IRS says, "Contemporaneous daily time reports, logs, or similar documents are not required if the extent of such participation may be established by other reasonable means."2

In this context, the IRS says that other reasonable means 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 period, based on appointment books, calendars, or narrative summaries."3

Wow! The time log sounds easier than the "other reasonable means."

What the Courts Say

In what should be no surprise, the courts have consistently ruled against taxpayers who arrive in



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court without proof of time spent.

AuditProof Your Time Spent on Rental Properties

In a recent court case regarding time, Peter Ackerman brought three witnesses to court to corroborate his claim of more than 750 hours of material participation. The court was looking for a documented record of time spent and considered the testimony lousy proof accordingly, the court denied Mr. Ackerman's losses.4

In the Scheiner case, Mrs. Barry Scheiner testified as to time spent working, but she had no supporting written documentation. The court stated, "Given the selfserving nature of Mrs. Scheiner's testimony, coupled with the lack of corroboration in the record, we do not accept her naked assertion that she worked the requisite amount of hours . . ."5

What Does This Mean to You?

In simple terms: keep a time log.

In an audit of your real estate activity, the IRS tells its examiner:

Request and closely examine the taxpayer's documentation regarding time. The taxpayer is required under Reg. Section 1.4695T(f)(4) to provide proof of services performed and [of] the hours attributable to those services.6

The audit guide also tells the examiner to7

? question you during the initial interview about the time you spend in all your activities (personal, business, civic, family, hobbies, etc.)

? question you during the initial interview about your material participation ? present you, possibly during the initial interview, with the IRScreated spreadsheet that

you can use to establish your services and hours

? look for time spent by others in your rental activity, by examining commissions management fees expenses for cleaning, maintenance, repairs etc.

Click here to see the spreadsheet that, according to the IRS audit guide, the examiner should give you so you can document time spent in your rental activity. Note that you complete this log under penalties of perjury and that it asks about

? hours spent ? services performed by husband or wife and, ? if requested, how the IRS could verify your assertions.

We note that you are preparing this IRS spreadsheet of time worked well after the fact, when your lack of recall is going to work against you. The courts note this lack of recall often as they deny the deductions for lack of timely proof.

So, here is a question for you: would you rather wait for the IRS to ask you to complete the



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AuditProof Your Time Spent on Rental Properties

spreadsheet from information you probably don't have, or would you rather keep a simple time log that makes the IRS go away, like the one below?

Note that we simply added some time notes to the vehicle log. This type of log really auditproofs your vehicle and time spent.

The log shows that it was kept on a timely basis. It also contains an audit trail to your corroborative evidence. For example, you noted in your log the purchase of the hose from Home Depot, and this rental stop ties into your corroborative evidence--the purchase receipt from Home Depot.

Elements of Time You Need to Know

Commuting to your rental properties produces personal mileage. If commuting mileage is personal, time spent commuting is personal--so says the IRS to its examiners.8 Thus, consider establishing an



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AuditProof Your Time Spent on Rental Properties

office in the home for your rentals so that your trips from your principal office to the rental produce deductible mileage, which, in turn, produces countable work time (travel time from one work location to another).

Section 179. The trip from the home office to the fourplex apartment building generates business miles (not investment miles).9 However, you are in a special category, BusResidRental, because this

fourplex is used to furnish lodging. Business miles in connection with lodging do not count as Section

179 miles for purposes of achieving the morethan50percent business use required for Section 179 expensing.10

Note. The lodging limitation on Section 179 expensing does not apply to rentals that qualify as hotels.11

For details on the mileage rules, see the short video on keeping mileage. Click here.

If you are married and both husband and wife work on the rental activity, each should keep a time and mileage log.

Threemonth log. You may keep a mileage log for three months during the year to prove mileage for the year, providing that the three months produce an accurate approximation.12

The difficulty of the threemonth log compared to keeping the log all year is that you have to start a new habit each year. Many subscribers tell us that once they have the habit of keeping the mileage log, it's no longer a big deal to keep the log all year, each year.

Investor time. You may count your investor activity time as material participation time only when you are directly involved in daytoday management or operations.13 Investor activities include14

? studying or reviewing financial statements or reports, ? preparing or compiling summaries or analyses for the individual's own use, and ? monitoring finances or operations in a nonmanagerial capacity.

If you and your spouse are the only ones who do any work on the rental, you are actively involved in everything, including daytoday management.

Time in a Capsule: A Brief Review

If you want to deduct your rental property losses using the rules that apply to the real estate professional, you and/or your spouse need to track time so that you can prove

? that you spend more hours on your real estate activities than on other activities ? that you spend more than 750 hours on your real estate activities and ? that you materially participate in each property or, if grouped, in the rental group.

Click these links for related articles on material participation and real estate professional status.



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AuditProof Your Time Spent on Rental Properties

1 Reg. Section 1.4695T(f)(4). 2 Ibid. 3 Ibid. 4 Peter Ackerman v Commr., TC Memo 200980. 5 Barry H. Scheiner v Commr., TC Memo 1996554. 6 IRS Passive Activity Loss Audit Technique Guide (ATG), Training 3149115 (022005), pp. 26, 48. 7 Ibid. 8 The IRS, on pages 49 of its Passive Activity Loss Audit Technique Guide, tells its examiners, "Travel time generally should not be considered in computing the hourly tests for material participation, particularly if other factors indicate the taxpayer is not participating in the activity on a regular, continuous, and substantial basis." The IRS's endnote reference for this comment states: We have no express statutory guidance on travel. While not precedent setting (it is just a summary opinion), the following case provides guidance on travel time: Thomas E. Truskowsky v Commr., TC Summary Opinion 2003130. 9 Smith v Commr., 83 TC 702 Bolaris v Commr., 81 TC 840 Curphey v Commr., 73 TC 766. 10 IRS Pub. 946, How to Depreciate Property (2008), pp. 17, 18. 11 Ibid. 12 Reg. Section 1.2745T(c)(3)(ii)(C), Example 1. 13 Reg. Section 1.4695T(f)(2)(ii)(B). 14 Ibid.

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