Some people are drawn into the real estate game largely for the potential tax benefits — done right, for example, you can leverage any real estate losses you sustain into some generous deductions for business expenses. There’s a catch, though: You can’t be engaged in your real estate activities just to generate losses. If the IRS finds that you lack a profit motive, it will limit and perhaps disallow your deductions altogether. One taxpayer recently learned that the hard way.
In Long v. Comm’r, the taxpayer was issued a real estate broker’s license in California in November 2009. He never generated any income from his real estate activity in the years at issue, 2010 and 2011.
He did, however, claim deductions for expenses related to his real estate activity totaling $103,760 and $52,367 for 2010 and 2011, respectively. The IRS determined the taxpayer had income tax deficiencies based on the deductions and assessed accuracy-related penalties. The taxpayer appealed.
Tax law allows business loss deductions only if the taxpayer engaged in the underlying activity for profit. If the engagement wasn’t for profit, the law limits deductions to the amount of gross income generated by the activity. In other words, if the taxpayer in this case wasn’t trying to generate a profit from his real estate activities, he wasn’t entitled to any of his claimed deductions because he reported no gross income from those activities.
The U.S. Tax Court cited nine nonexclusive factors relevant to the determination of whether a taxpayer engaged in an activity for profit. It found that these factors weighed against the taxpayer’s claim that he engaged in real estate activities for profit. Several factors in particular worked against him:
There’s no such thing as a free tax break. If you want to take full deductions for losses on real estate activities, you’ll need to be able to prove that you engaged in those activities for profit.
Contact Adam Hill at ahill@cohencpa.com or a member of your service team for further discussion.
Cohen & Company is not rendering legal, accounting or other professional advice. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts and circumstances.