As the year ends, it’s time to get things in order for your tax returns. A friend of ours owns rental properties was audited last year. She shared some interesting items that you may find helpful:
“Nevadans (she lives in Nevada) are audited 150% more than people living in Wyoming.
In the 2010 JK Lasser Real Estate Investors Tax manual it states, more or less, (copyright laws):
If you show a lot of income besides the real estate income, the IRS thinks you have a full time job and so they think you cannot spend more than half your time in your real estate business so they may select you for an audit.”
– My Note: The real estate professional status is based on hours that are performed in real estate functions. You must spend more time in real estate activities than in any other activity for which you are compensated to claim real estate as your profession on your return and to get the tax advantages of working in a real estate business.
One of the biggest benefits to investing in real estate is the ability to offset the real estate paper losses (primarily caused by depreciation) against your other income. If you can qualify as a real estate professional, then 100% of your paper real estate losses may be used to offset your other income. –
“The Internal Revenue Service is going after real estate professionals, so if you are claiming this status on your tax return, you need to be aware that the IRS is after you. They are now auditing a lot more real estate professionals and they are using their own rules to disqualify enough hours of your real estate professional activities so that you no longer qualify as a real estate professional.
The Internal Revenue Service is going over every hour of activity that taxpayers claim and then disallowing enough hours so that the taxpayer cannot meet either the 750-hour test or the one-half-time test.
There are certain items on your return that attract the attention of the IRS:
They look at the occupation line on the tax return (where you sign and it asks for your job description) to see if it states that you are in real estate.
If you have rental properties that are out of state and a property manager is used, they will check the Schedule E on your tax return to see if both the property management expense lines are completed, as well as to see where the property is located. The IRS is claiming that any time spent with property managers will not count toward real estate professional time since it shows them that you did not materially participate in the property. This is a good reason to hold your rental property in a separate entity; doing so will eliminate the Schedule E from your tax return (and instead will be reported on a separate tax return).
Large travel expenses are listed on Schedule E.
The Internal Revenue Service is making the argument that time spent looking for new property does not count toward your real estate professional time and instead is considered investment time..”
A qualified real estate activity is any thing in which you “develop, redevelop, construct, reconstruct, acquire, convert, rent, operate, manage, lease, or sell” real estate. If you are claiming to be a real estate professional on your tax return, you must be able to substantiate 750 hours worked in this profession and show that this was more hours than you spent in any other business endeavor.
Be sure to keep good records, dates and receipts.
What can you share to help other investors with preparing their tax returns?