Real Estate Professional Tax Issues With the IRS

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The IRS continues to target tax return with real estate losses for audit. If you’ve taken the real estate professional status, you may especially be at risk for an audit. There is also a chance that the agent auditing your return might get it wrong.

There have been some changes in tax law that have not been updated on the Audit Technique Guide (ATG) that the IRS agents use to conduct an audit.

Problem #1: You are a limited partner in a limited partnership that holds real estate.

The IRS auditor may claim that you can not materially participate and therefore you have passive income or loss. The IRS came out with Regulations at the end of 2011 regarding this, stating that if a limited partner acts like a general partner, regardless of what state law says, then he can materially participate. That’s good news for your tax issues, but could be bad news for asset protection. You don’t want to be treated like a general partner otherwise.

If you’re currently holding your property in a limited partnership, we are recommending that you roll the structuring into a manager-managed LLC. That will give you the tax deduction plus the asset protection.

Problem #2: The ATG is confusing and auditors are misapplying the law as a result when it comes to the required hours for real estate professionals.

A real estate professional needs to have both at least 750 hours of real estate activities plus more hours in real estate activities than any other trade or business. That’s test #1. A real estate professional also needs to materially participate in the property, which means 500 hours or more per property per year.

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