Tuesday, September 21, 2010

“On Call” Time didn't Count Towards Qualification as Real Estate Professional Under PAL Rules

Moss (2010), 135 TC No.18

The Tax Court has held that the time that a taxpayer was “on call” to perform activities for his rental properties didn't count toward satisfying the 750-hour service performance requirement for a real estate professional under Code Sec. 469(c)(7)(B) of the passive activity loss (PAL) rules. As a result, the taxpayer's losses from his rental properties were limited to the $25,000 allowance under Code Sec. 469(i) (subject to phaseout limitations).

Background. Under Code Sec. 469(c)(1), the passive activity loss disallowance rules apply to any trade or business in which the taxpayer does not materially participate. A taxpayer is treated as materially participating in an activity if he meets at least one of the seven tests in Reg. § 1.469-5T. In general, any rental activity is per se a passive activity regardless of the taxpayer's participation in the activity. (Code Sec. 469(c)(2)) However, there are two principal exceptions to the general per se rule: (1) the qualifying real estate professional rule under Code Sec. 469(c)(7); and (2) subject to conditions and limitations, an individual who actively participates in a rental activity may deduct up to $25,000 of losses from the activity against nonpassive income under Code Sec. 469(i).

The Code Sec. 469(c)(2) per se rule for rental activities doesn't apply to a qualifying real estate professional. A taxpayer qualifies as such for a particular tax year if:

1. more than half of the personal services that he performs during that year are performed in real property trades or businesses in which he materially participates; and

2. he performs more than 750 hours of services during that tax year in real property trades or businesses in which he materially participates. (Code Sec. 469(c)(7)(B))

Observation: A taxpayer who is a qualifying real estate professional isn't automatically entitled to treat a real estate rental activity as non-passive. He must meet the general material participation standard with respect to that activity in order to use its losses or credits to offset non-passive activity income.

In the case of a joint return, the requirements for qualification as a real estate professional are satisfied if either spouse separately satisfies the requirements. Thus, if either spouse qualifies as a real estate professional, the rental activities of the real estate professional aren't per se passive under Code Sec. 469(c)(2). (Code Sec. 469(c)(7))

A natural person who: (1) has at least a 10% interest in any rental real estate activity, and (2) otherwise actively participates in that activity, may offset up to $25,000 of nonpassive income with that portion of the passive activity loss, or of the deduction equivalent of the passive activity credit, attributable to that activity. The $25,000 allowance ($12,500 for marrieds filing separately) is reduced (but not below zero) by 50% of the amount by which taxpayer's adjusted gross income (AGI) as specially computed exceeds (1) $100,000 ($50,000 for marrieds filing separately), or (2) $200,000 ($100,000 for marrieds filing separately) for any portion of the passive activity credit that is attributable to the rehabilitation credit. (Code Sec. 469(i))

Facts. James and Lynn Moss owned rental properties (four apartments and three single family homes) that generated losses for the year in issue. James worked full time at a nuclear power plant (40 hours a week, plus “call out” time (where an employee works unscheduled overtime) and “standby time” (where an employee is ordered to await a call for emergency work outside scheduled working hours).

The Mosses contended that they weren't subject to the Code Sec. 469 passive activity loss limitations because James qualified under the real estate professional exception. They offered a summary of the time James worked on the rental properties. The summary showed that James worked on the properties for less than the 750 hours required by Code Sec. 469(c)(7)(B)(ii) . However, the taxpayers contended that, in addition to the time James actually worked, he was “on call” for work on the rental properties during the time that he wasn't at his full-time job and that the “on call” hours should count toward meeting the 750-hour requirement.

They don't serve who only stand and wait. The Tax Court held that James' time being “on call” didn't count toward satisfying the 750-hour requirement under Code Sec. 469(c)(7)(B) because he didn't perform any actual work on the rental properties during the “on call” hours. Accordingly, the losses from the taxpayers' rental properties were subject to the limited offset allowed under Code Sec. 469(i).

Research References: For real estate professionals (qualifying taxpayers) defined under passive activity loss rules, see FTC 2d/FIN ¶ M-5168; United States Tax Reporter ¶ 4694.63; TaxDesk ¶ 413,808. For the $25,000 allowance for active rental real estate owner, see FTC 2d/FIN ¶ M-5131; United States Tax Reporter ¶ 4694.60; TaxDesk ¶ 413,601.

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