Proving ‘Material Participation’ In Today’s Digital Age

The fight over who meets the definition of a “real estate professional” is not a new one. Fortunately, the taxpayer’s burden for satisfying that definition has only been eased by the expansion of digital tools available for tracking time. That being said, the United States Tax Court’s (Court’s) memorandum opinion in Hairston v. Comm’r of Revenue, T.C. Memo. 2019-104, 2019 BL 311425, is a good reminder that those digital tools still must be deployed effectively.

Ronnie Hairston owned two rental properties and performed various activities related to those properties. Some of these activities included the following: cutting the grass and removing snow, remaining onsite while other workers were completing major maintenance projects, advertising the properties, fielding questions from prospective tenants, showing the properties to those prospective tenants, and screening applicants via credit reports and background checks.

In the 2014 tax year, Ronnie’s expenses exceeded his income with regard to his rental properties and he deducted the net loss against his ordinary income. Ronnie maintained a calendar for each rental property that allegedly showed the hours he spent working each day. These calendars contained 360 separate entries and confirmed that he spent more than 750 hours on his rental properties. The Internal Revenue Service (IRS) disputed that Ronnie spent 750 hours and, as a result, treated his losses as passive losses and that were therefore nondeductible in the 2014 tax year.

Pursuant to Internal Revenue Code (I.R.C.) Section 469(c)(2), rental activity is presumed to be treated as a passive loss and not deductible against ordinary income. If a taxpayer can demonstrate that, pursuant to I.R.C. Section 469(c)(7)(B)(ii), they are a “real estate professional,” then those losses can be deducted against ordinary income.

In the Hairston case, the Court agreed with the IRS that Ronnie’s calendars were insufficient evidence to confirm he performed 750 hours of service. Specifically, the Court noted that a number of Ronnie’s entries were for one hour, regardless of how long it might have taken him to complete. For instance, there were 13 distinct, one-hour entries for “paying mortgage” in his calendars. Ronnie also included 33 hours supervising the cleaning and installation of carpet and 40 hours of supervising contractors’ who were painting the property.

The Court had decided in Moss v. Comm’r of Revenue, 135 T.C. 365 (2010) that time spent watching contractors did not qualify as providing services. The contractors in the Moss case were doing the work, not the taxpayer. The Court decided that being “on call” for those contractors did not constitute providing service pursuant to I.R.C. Section 469(c)(2).

Ultimately, the Court accepted the IRS’s treatment of Ronnie’s losses because he failed to keep adequate books and records relating to the time he spent on his rental properties. This is certainly not a new phenomenon. That said, the advent of a number of digital tools, like Google calendars or Track My Drive, make it much easier for taxpayers to substantiate the time they are spending on their real estate activities. Though, as has been the battle from the beginning, if these tools are not deployed effectively, it will still not be enough to substantiate the requisite time spent.