Dennis Norman
By:Dennis Norman
Now,before anyone gets too excited about this decision let me start with a big disclaimer: Because of the nature of this tax case PURSUANT TO INTERNAL REVENUE CODE SECTION 7463 (b),THIS COURT OPINION MAY NOT BE TREATED AS PRECEDENT FOR ANY OTHER CASE.
Now,having said that,I think there is still some good information in this case. The case is “Shri G. and Sudha Agarwal v. Commissioner of Internal Revenue,docket No. 12670-07S. According to the summary opinion from the tax court the facts of the case are as follows:
- Mr. Agarwal worked full-time as an engineer
- Mrs. Agarwal worked as a license real estate salesperson
- The couple owned two rental properties in which Mrs. Agarwal managed
- The rental properties expenses exceeded the income so a loss was generated
- The Agarwal’s used the loss from their rental activity to offset other income
- The IRS disallowed the deduction of the rental loss as they said the rental properties were a “passive”activity thereby only allowing the loss to be deducted in an amount not to exceed the total passive income.
The term “passive”activity probably is not a new term to many readers. If you are an investor and have had losses you may have received the bad news before from your tax preparer that your rental losses may not be able to be used to offset your other ordinary income.
The IRS does,when certain tests are met,consider operating rental property not to be a “passive”activity. This court decision quotes the section of the IRS code that addresses this;
Under section 469(c) (7),rental activities of a qualifying taxpayer in a real property trade or business are not a per se passive activity under section 469 (c) (2). Rather,the qualifying the taxpayer\’s rental activities are treated as a trade or business–subject to the material participation requirements of section 469 (c0 (1). And in determining whether a taxpayer materially participates,the participation of the taxpayer\’s spouse is taken into account. Sec. 469 (h) (5).
A taxpayer may qualify for the real property trade or business expectation if:(1) More than one-half of the personal services performed in trades or businesses by the taxpayer during the taxable year are performed in real property trades or businesses in which the taxpayer materially participates;and (2) the taxpayer performs more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates. Sec. 469 (c) (7) (B) (i) and (ii). In the case of a joint return,either spouse must satisfy both requirements. Sec. 469 (c) (7) (B).
The IRS argued that because Mrs. Agarwal was a license real estate salesperson and not a broker and according to state law for the state in which she was licensed she could not operate a real estate business,but instead had to be associated with a broker,that she was not,for the purposes of the exemption,“in”the real estate business.
The court determined that “consistent with her real estate salesman’s license and pursuant to her contract with the brokerage firm,Mrs. Agarwal was engaged in “brokerage”‘;i.e.,she sold,exchanged,leased,or rented real property and solicited listings. Therefore,Mrs. Agarwal was engaged in a “brokerage”trade or business within the meaning of section 469 (c) (7) (C). ”
The court’s decision went on to say “because Mrs. Agarwal owned an interest in rental property,performed more than one-half of her personal services in real property trades or businesses in which she materially participated,she is a qualifying taxpayer. See sec. 469 (c) (7);sec. 1.469-9 (b) (6),(c) (1),Income Tax Regs. Because Mrs. Agarwal is a qualifying taxpayer and she materially participated with respect to each property,(the Agarwals) are entitled to deduct their….Schedule E losses.”
What is significant in the courts decision,in my opinion,is that the court accepted being a licensed real estate salesperson as being in the “brokerage”business and thereby allowing the Agarwal’s to use their rental losses to offset ordinary income. If you read the entire case you will see that Mrs. Agarwal wasn’t that successful as an agent as she lost money in one of the years in question and netted less than $1,000 in commissions the next but I will bet after this decision she and her husband were kissing her real estate license!
FINAL DISCLAIMER:I’M NOT AN ATTORNEY,CPA,TAX PROFESSIONAL,TAX ADVISOR OR ANYTHING SIMILAR. THIS INFORMATION IS BEING REPORTED AS “NEWS”AND FOR INFORMATIONAL PURPSOSES ONLY. IF ANYTHING IN THIS ARTICLE HAS INFLUENCED YOU IN ANY WAY CONSULT YOUR TAX PROFESSIONAL AND TAX ATTORNEY BEFORE DOING ANYTHING.
TO COMPLY WITH CERTAIN U.S. TREASURY REGULATIONS,WE INFORM YOU THAT,UNLESS EXPRESSLY STATED OTHERWISE,ANY U.S. FEDERAL TAX ADVICE CONTAINED IN THE TEXT OF THIS COMMUNICATION,IS NOT INTENDED OR WRITTEN TO BE USED,AND CANNOT BE USED,BY ANY PERSON FOR THE PURPOSE OF AVOIDING ANY PENALTIES THAT MAY BE IMPOSED UNDER THE INTERNAL REVENUE CODE.
Hopefully that about covers it for disclosures and disclaimers.
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