Are you a “Real Estate” professional in the eyes of the IRS?

It does not matter if you are a bookkeeper, Enrolled Agent, CPA, Attorney or an employee of the IRS the tax code is daunting and easy to misinterpret.  Even if you understand it the application of the regulation presents a further complication.  An area in my tax practice where I see mistakes routinely made is in the application of the title “Real Estate Professional”, section 469 of the IRS code deals with this topic specifically. 

Recently I was contacted by a potential client.  The IRS had sent him a notice that they were going to audit him.  He retained me for representation during the audit.  Being defined as a Real Estate professional is very advantageous to the tax payer.  The biggest advantage is that the passive activity loss limitations no longer apply.  Also Real Estate professionals are able to exclude rental income from the additional 3.8% tax on net investment income.  This client, named Jed had 3 rental properties and ran a business doing construction/home repairs and improvements.  He self-prepared his taxes by hand.  Between him and his wife they had a joint MAGI income which was in excess of $150,000.  He had claimed on his return that he was in fact a “Real Estate” professional.  But
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Real Estate investing provides many tax benefits, and depreciation is one of the biggest. It’s also one of the more misunderstood.

Depreciation lets you deduct a portion of the cost of the investment each year for the length of its IRS-designated life span.  The depreciation computation is figured based on the value of the improvements, not on the land underneath the improvements.  This necessitates that you be able to determine the value of the land and the value of the improvements.  This determination is generally included in the multitude of closing documents you received when buying the property or found on the county Real Estate tax website.  It is essential that you keep your closing documents.  There are additional costs that can be expensed and loan costs that must be amortized involved in the closing itself.

A recent client case provides a good example for this deduction and how it can be forgotten.

Joe, an old Army buddy into my office asking for help with his taxes.  He had done his taxes up to this point as he had a pretty simple tax situation but about two years ago he moved and turned his old primary home into a rental property.  The first year of owning his home he had done his taxes and he had read some articles about depreciation and expenses that had gotten him thinking that maybe he had done something wrong on his taxes so the following year when his taxes were
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