From a tax point of view, Real Estate investments can have significant tax advantages if you meet the real estate professional requirement as you might be able to offset active or earned income from one spouse against the active or earned losses of the other spouse. For high earning couples, one can be a high w2 employee o high income business owner and the spouse can focus (or actively pursue a career) on the Real Estate investment world.

Less than a year ago, we got another reminder of the importance of keeping track of your Real estate hours and appropriate support documentation in the case of James Michael Warren v. Commissioner of Internal Revenue. 

In 2017, Mr. Warren was employed full-time as an engineer at Lockheed Martin, working 1,913 hours, while also engaging in renovation activities for the group home (side hustle and not primary activity). He set up Warren Assisted Living, LLC, to operate a group home offering professional caregiver services. 

The Tax Court ruled in favor of the IRS (disallowing Real estate losses), determining that Mr. Warren did not meet the criteria to be considered a real estate professional:

  • Time Requirement: To qualify, a taxpayer must spend more than 50% of their working hours and at least 750 hours per year in real estate activities. Mr. Warren logged 1,913 hours as an engineer and only 1,628 hours on the group home, less than 50%. Also, other issues was that on aggregate was working around 70 hours a week (no holidays) and he created the time log just before appear for trial.

  • Documentation: He lacked contemporaneous records to substantiate the time spent on real estate activities, which is essential for such claims. As we always mention, good books and records are the first line of defense in any IRS examination. 

  • Income Threshold: His adjusted gross income (AGI) was $199,974, exceeding the $150,000 limit for passive loss deductions under § 469(i), making him ineligible for the $25,000 exception for active participation. When your income is higher than the threshold, you cannot offset rental passive losses but it will accumulate until you dispose (sell) the rental property. 

Follow us and reach out to our team for professional tax advice tailored to your personal situation as there might be other options to get tax advantages.