If you are involved in construction and reconstruction, you may get a better deal on your losses from rental real estate and beginning with 2013 avoid the Obamacare tax on gains from rental real estate. But what exactly is construction and reconstruction? The Tax Court had to look it up in the dicitionary. Here’s the story.
Some Background
The , which introduced the oxymoronic concept – passive activities. Other sections of the Code, like those concerning S corporations discuss “passive income” – interest and dividends and the like, but such investment income is not the passive activity income that 469 refers to. Passive activity income and more significantly loss comes from a trade or business activity in which you do not materially participate. We are required to divide our trade or business income from proprietorships, partnerships and S Corporations into two buckets. If the passive bucket is a net loss, the loss is suspended and carried forward to be used if there is passive income in the future or when the underlying activity is entirely disposed.
The rules about how you classify your activities and measure material participation are mind boggling in their complexity. Don’t get me started. There is one rule that created a lot of angst, though. Rental activities are per se passive. This was troubling to people in the real estate industry who might for example have rental losses on a development while making money on the sale of property. So a special rule was created for people involved in real estate trades or businesses. If you spend more than 750 hours per year in real estate trades or businesses and the amount of time that you spend in the real estate trades is greater than the amount of time you spending doing anything else, then the per se passive rental income rule does not apply to you. Rental losses are not passive, if you materially participate in the related properties.
Not Easy For People With Day Jobs To Be Considered Real Estate Pros
For some reason, the IRS is particularly zealous in enforcing Code Section 469. If you have substantial income and are posting losses from rental activities, you can put as many “I love Obama” signs on your lawn as you want and you still have a better than average chance of being challenged. At least that is my inference from the cases I read and some discussions with other practitioners.
The way the cases have broken, people with non-real estate day jobs who claim that they spend more time on their amateur landlord activity are almost always accused of having insufficient records of their time, “ballpark guestimates, a colorful term that the Tax Court seems to have reserved for 469 cases. Even in the cases where people have logs, they are often found to be improbable.
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