Audit Hell
My husband and I own a three family brownstone (we live in the bottom) and rent out the top two apartments. We have just been audited for 07 and 08 and need to pay back in full all the deductions we received for maintaining and fixing up our apartments. We can fight it if we…
My husband and I own a three family brownstone (we live in the bottom) and rent out the top two apartments. We have just been audited for 07 and 08 and need to pay back in full all the deductions we received for maintaining and fixing up our apartments.
We can fight it if we can prove that we spend over 750 hrs managing our apartments/tenants needs etc (easy), and I think as well we need to prove we are real-estate professionals (that one of us spends more than 50% in the real-estate industry (we don’t as both have work in other professions).
wanted to see if anyone has any advice, been successful in winning a similar case and if you do need to prove your a real-estate pro. We have engaged an IRS lawyer but before we start racking up his fees want to see if we should suck it up and pay it all back.
Cheers
small clarification,
You are allowed to deduct up to the amount of passive income on that property. You are allowed an additional 25K in deductions (special allowance) if you “actively” participated in management of the income property. That 25K special allowance is phased out between 100k-125K of active income.
You are only allowed to deduct the entirity of passive activity loses from all income (passive + active) if you are a “real estate professional”. That is, you meet the two criteria stated above.
IMO I think it will be harder than you think to document that you spend more than 750 hours/year managing two rentals in your house. That’s saying that you spend 15 hours a week with only two weeks off. I am sure there are months when that happens, but I think it will be hard to show that consistently through the year.
The IRS has made the investor/owner deductions a “project” issue over the past few years. This means the IRS is aggressively pursuing all those folks who invested in real estate over the past run up and took large deductions from passive income off their entire (passive + active) income.
Northridger has it right about the specifics as far as I understand them.
You have to consider if you want to fight this, if you do,you must be able to prove more than 750 hours spent in real estate activity over each of those years. This should not be difficult for any active homeowner/landlord. Keep in mind the second stipulation though; your hours spent in real estate activities have to be more than those spent in your profession/job. So you must have more hours in real estate activity documented on a log/calender with specific activities, than you do on accumulated W-2 forms from your day job.
Of course, you will also have to back up all your deductions with receipts and checks and bank statements.
If you do not meet those criteria, you are only allowed to deduct up to 25,000 per year (special allowance) which phases out between 100k-150k per year. The overages can be applied as deductions on successive years or upon sale of the property.
Do not give the IRS anything regarding schedules or hours until the Tax attorney has approved it. Everything you give them can be used against you later.
Good luck.
it sounds like you need roni deutch to make a tax settlement….
the cost of a renovation vs repairs – technically speaking, according to the irs, if it’s attached to the wall and the value is over a certain dollar threshold – it’s a capital improvement and does not get deducted the way a repair does. it does not get added to the cost of the house either – it is its own event, gets depreciated over 27 1/2 years just as the portion of the house that is rental property does – but gets its own line on a schedule e. at the time the property is sold, any depreciation taken from the time each capital improvement is put into service until the date of sale is recaptured by subtracting it from the cost basis, thereby making the gain larger by an equivalent amount. as the gain is taxed (depending on holding period) as a long term capital gain, it gets paid out at a lower rate than that at which it was depreciated over the time deductions were taken, as those are taken at the taxpayer’s nominal rate. also, the recapture happens at some time in the future, making the dollar value of the recapture lower as well.
as for deductions for real estate: deductions for owning a home exist to get people to buy houses and to enable them to afford to stay in them. real estate professionals who make a living managing real estate get deductions the same way any other owner of a business gets deductions for legitimate business expenses. the preferential treatment of real estate is to the benefit of the homeowner.
Also.. since u are not a real estate professional the max u can deduct for real estate related expenses yearly is $25K..all extras I carry over the next year.
This is a really good article that explains the whole “real estate professional” tax deduction thing:
http://www.investopedia.com/articles/pf/06/rentalowner.asp
I don’t know much about this area, this is all personal google-fu 🙂
The relevant paragraph:
” If you spend the majority of your time in the real estate business as a real estate professional, your rental losses are not passive. This means that your losses are fully deductible against all income, passive and non-passive. Otherwise, your losses are passive and only deductible up to $25,000 against your rentals’ income (deduction phases out if your modified adjusted gross income (MAGI) is between $100,000 and $150,000). However, losses of more than $25,000 can be carried over to the following year.
The IRS defines a real estate professional as someone who spends more than one-half of his or her working time in the rental business. This includes property development, construction, acquisition and management. You must also spend more than 750 hours per year working on your real estate rental properties. (To find extra resources about owning rental properties, see Investing In Real Estate and Tips For The Prospective Landlord.)”
Like I’ve said in other threads..if you’re making individual deductions of >$10K then see a tax professional.
As a complete aside, you think it’s easy to claim that you’ve worked more than 14 hours/week managing your building? Sounds like quite a stretch to me…
Sorry.. Schedule E. You are not real estate professionals..at least not classified by the IRS. I own properties and I know the time it takes but until they reclassify …Schedule E .. you should call IRS 1800 number anonymously. They are chock full of info.
In amortizing a rent generating unit’s expense, it was understood that it be on Schedule E as I mentioned above.
But you are correct about any maintenance or capital repairs to their aprtment.