IRS versus Real Estate Professionals

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The IRS continues their targeted audits of real estate professionals. However, due to cutbacks, they’ve lost a lot of the high level auditors, so the current auditors tend to be ones who just follow Audit Technique Guides and aren’t personally interpreting law. For that matter, I’m not sure that they are well versed in the law and seem to be MIS-interpreting the law.

Here are some of the challenges we’re seeing that the IRS is making toward real estate professionals. Some of the challenges are valid, some…well, read on and you’ll get the gist.

  1. Invalid material participation due to wrong entity set-up. In general, the IRS is looking to make sure that the property is held in the proper entity and that the entity’s agreements are written properly. Being a limited partner in a Limited Partnership won’t work, and even being a passive Member in an LLC might not work if the Operating Agreement isn’t written in a specific manner.
  2. Invalid material participation due to missing aggregation election. The aggregation election is made on your return. If it’s not made and attached to your tax return, you can lose the deduction. However, if you’re audited, the IRS auditor will allow you to make a late aggregation election at the time of the audit. This has become a non-issue.
  3. Invalid material participation due to ‘inactive’ activities. You can’t count the time you spend researching real estate, or Internet surfing as real estate activity. You need to actually be active and working on or in the properties.
  4. Undocumented REP hours. It’s important to keep a Day-Timer and track your time to clearly show you have spent at least 750 hours per year. Other tracking methods can help here, too. For example, take pictures of yourself at your properties, or at meetings with construction workers, property managers, etc. and keep them in your REP file.
  5. REP hours not active. This is similar to the inactive material participation activities.
  6. REP Hours Exceeded by Other Activities. Remember, it isn’t just 750 hours period. If you have another income-producing business or job, you must spend more time doing your REP activities than other income-producing activities.

Some of the mistakes have to do with not understanding the difference between the first two tests, real estate professional hours versus other trade or business and material participation hours. In that case, it is often the auditor that is wrong.

Federal and state tax audits can be stressful, expensive and time consuming. If you do get selected for audit, the more you can do to minimize the audit and contain it, the better. One of the topics I’ll be covering soon in our coaching program has to do with surviving and IRS audit.

To find out more about our coaching program, go to: For a private consultation with me, give Richard a call at 888-592-4769.

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