Why Proving Real Estate Professional Status Can Be Challenging

Many investors use rental property losses to offset taxable income. However, qualifying as a real estate professional—which allows full deductions of rental losses—requires meeting strict IRS rules. A new case, Foradis, TC Summ. Op. 2024-13 (7/11/24), shows just how difficult it can be to prove the required hours, especially when balancing a full-time job.

The Tax Court rejected a taxpayer’s claim that he spent 2,500 hours on rental activities while working a full-time job. The judge found the claim “implausible” and ruled that the losses could not offset non-passive income.

Understanding Rental Activity Loss Deductions

Passive Loss Limitations

Under tax law, rental real estate is generally considered a passive activity. This means that passive losses (such as rental property losses) can only offset passive income—not wages or business income.

However, there are two exceptions:

1. Active Participation Rule:
   1. Allows a limited deduction of up to $25,000 in rental losses against regular income.
   2. Requires active participation in managing the property.
   3. Phased out for taxpayers with a modified adjusted gross income (MAGI) between $100,000 and $150,000.
2. Real Estate Professional Status:
   1. Allows unlimited deductions for rental losses against all income.
   2. Requires 750+ hours of real estate activities annually.
   3. More than 50% of total working hours must be in real estate.

The third requirement—spending more than half of total work time in real estate—proved to be the downfall in the Foradis case.

The Foradis Case: Failing the Time Test

Case Facts

1. A married couple filed jointly in 2020.
2. The husband had taxable wages of $78,000 and worked full-time (40 hours per week).
3. They built and rented out a carriage house and claimed a $22,000 rental loss deduction.
4. Their MAGI exceeded $150,000, disqualifying them from the $25,000 active participation loss deduction.
5. Instead, they claimed real estate professional status to deduct the full loss.

IRS Challenge

To qualify, the husband needed to show he spent:

1. More than 750 hours on real estate.
2. More time in real estate than in his full-time job (~2,000 hours).

He claimed 2,500 hours working on the carriage house, logging time spent on construction, management, and other tasks. He provided logs and receipts and testified in court.

However, the Tax Court rejected his claim, concluding:

1. 40 hours/week at his regular job + 48 hours/week in real estate = 88+ hours per week.
2. That left only 80 hours per week for sleeping, commuting, eating, and everything else.
3. The court found this “implausible” and ruled against him.

Key Takeaways for Real Estate Investors

1. Track Your Time Accurately – Keep detailed records of real estate work, including dated logs, invoices, and contracts.
2. Be Realistic – Courts may scrutinize excessive hour claims, especially if you have a full-time job.
3. Understand IRS Rules – If real estate isn’t your primary job, qualifying as a real estate professional can be very difficult.
4. Consider Professional Advice – Tax laws on rental losses are complex. Work with a tax professional to ensure compliance.

Bottom Line:

While real estate professionals can fully deduct rental losses, meeting the IRS time requirements is tough. The Foradis case proves that unrealistic hour claims won’t hold up in court.

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