Recordkeeping for the Real Estate Professional – Part 1
A recent tax court case involving Alvin Jones, an insurance agency owner, highlights some of the many challenges faced by busy professionals who, for tax purposes, seek to become real estate professionals. Mr. Jones owned and managed ten single-family homes in 2011 and eleven single-family homes in 2012. He spent a considerable amount of time complying with requirements for Section 8 housing to keep these properties full and cash-flowing.
After an audit by the IRS, Mr. Jones’s deduction as a real estate professional was disallowed because he was deemed not to be a real estate professional. A very important requirement to qualify as a real estate professional is the ability to prove that the majority of your work time is spent on real estate, not on any other activity.
In the case of Mr. Jones, the IRS compared his records for what he did regarding his real estate business with his records for his insurance agency. They were able to use his own recordkeeping against him. His insurance agency business had several on staff with sufficient payroll and a lot of revenue. Mr. Jones had also documented substantial mileage driven in both tax years relative to his insurance business. The IRS used this information to show that he spent more time being an insurance agent than he did being a real estate professional.
Unfortunately, the Jones did not receive good advice going into 2011 and 2012. If they had, they would have been told that Mrs. Jones could have kept records to show that SHE was the real estate professional, thereby giving them both the benefit when they filed as married filing jointly on their 2011 and 2012 taxes.
Mr. Jones should also have been advised to keep logs for both business activities as to how much time was spent each day on each business to document and be able to prove that he did spend more time being a real estate investor than he did being an insurance agent. Since you can’t go back in time and create records that are credible and reliable which can be submitted as evidence, I suggest you begin now in the early part of this year and keep records showing how much time you spend doing real estate versus any other business activity. I realize you chose to be a real estate investor because you want to be self-employed and have the freedom that goes with that, but there are times you have to prove you are doing what you claim to be doing when called into account by the IRS. Being able to defend the highly-coveted tax deduction of being a real estate professional is one of those instances.
In my next post, I will explain some of the technical recordkeeping that is required if you have other business endeavors besides being a real estate professional.