The final regulations under Internal Revenue Code section 469 (c) (7) were issued by the IRS on December 22, 1995. These regulations, which explain and interpret provisions regarding the rental real estate activities of taxpayers engaged in real property trades or businesses originally issued in the Omnibus Budget Reconciliation Bill of 1993, affect all taxable years beginning on or after January 1, 1995. While the new rules offer no relief for taxpayers that take no active part in real estate activities, ambiguity in the regulations allows some additional taxpayers to qualify their real estate rental losses as non-passive.
Although real estate professionals involved more than 50 percent of the time in their trade or business can already deduct their real estate losses as active losses, the possibility now exists that because of changes in what constitutes a real property trade or business, some investors may be able to receive non-passive treatment for their rental real estate losses.
Defining a Trade or Business
Although the phrase "trade or business" appears in more than 50 code sections, it is never defined. Indeed, instead of presenting a detailed definition, the final regulations provide that any reasonable method can be used for determining a taxpayer's real property trades or businesses. This ambiguity may open the door to individuals in fringe real estate businesses who now wish to qualify as real estate operators.
For example, Joan Miller is a lawyer with many real estate clients. Is her trade or business a real property trade or business? It is not clear if Miller's personal service hours would satisfy the test for real estate operator status.
In response to comments caused by ambiguities in the laws and the proposed regulations, the IRS has clarified that a qualifying real estate operator may count management activities toward material participation in real estate activities.
How Much Is 50 Percent?
Another ambiguity that still exists in the final IRS regulation is a method of determining whether the personal services performed meet the 50-percent/750 hours threshold. If a taxpayer's claim is challenged, substantiation of hours worked in various trades or businesses may not be readily available. However, Daniel N. Shaviro, Esq., contends that any reasonable means of proof - such as appointment books, calendars, and even narrative summaries - may be sufficient proof of time spent. In the absence of a record-keeping requirement in the regulations, the IRS may not be in a position to challenge such services as acceptable.
A Joint Deduction
Married taxpayers filing a joint return may not combine their efforts to satisfy either the personal service or material participation requirement for real estate operator status. However, if either spouse does satisfy both requirements and qualifies as a real estate operator for a tax year, all rental income activities for both spouses are eligible for potential relief from the passive-loss rules for that year. …