Up until recently, the IRS audit technique guides for auditors investigating real estate investor laws confused real estate professional hour requirements and material participation hour requirements. As a result, audit results were wrong and thousands of dollars were wasted on appeals, where the IRS was wrong and the taxpayer was right.
Thankfully, the audit handbooks were recently updated. If you find yourself in an audit of your real estate professional status, make sure your tax representative is up to date on the latest real estate professional and investor rules.
There is still one problem, as evidenced from the Audit Technique Guide for real estate investor audits at the end of November, 2012:
“___ Is the taxpayer a limited partner (and not also a general partner)? See IRC § 469(i)(6)(B). Note: Since many investors in low income housing are limited partners, losses will not qualify for the active participation standard and should be on line 3b. Therefore, no $25,000 offset is available. While LIHC are excepted from the active participation requirement, no such exception exists for LIH losses.”
It does state “and not also a general partner”, which is correct. If you are a limited partner and also a general partner, then you don’t necessarily have a passive activity. Unfortunately, auditors aren’t always seeing this distinction and as a result, there are some incorrect audit conclusions. Additionally, the LLC (limited liability company) isn’t clearly defined in the auditor handbook, although the IRS has published clear guidelines. Best bet, have a manager-managed LLC and make sure you’re named as one of the managers.
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