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Hey there, fellow real estate investors, FIRE enthusiasts, and tax aficionados! Welcome to "Real Estate is Taxing" – your go-to weekly podcast for all things real estate taxes, hosted by Natalie Kolodij, EA- Real Estate Tax Strategist and dry humor extraordinaire.
Each week, we're breaking down complex tax topics into bite-sized, understandable explanations, with no regard for how many obscure references it takes to get there.
Speaker: Welcome to Real Estate is Taxing,
where we talk about all things real estate
tax, and break down complex concepts into
understandable, entertaining tax topics.
My name is Natalie Kalady, I'm
your host, and I am so excited
that you've decided to join me.
Microphone (Shure MV7): Hello.
Hello everyone.
Welcome to this week's episode.
This summer has been a pretty
good summer for tax court cases.
And what I mean is that there have just
been several that I specifically have
enjoyed and thought were interesting.
And that's because there have been a
handful that relate to real estate.
Microphone (Shure MV7)-1: Now
I love anything court related.
I love reading true crime books.
I love listening to the podcast.
So for me, Reading tax court
cases is extra exciting.
But even if you do not
find that as cool as I do.
These are still something that you should
hold at least a little bit of interest in.
The tax code itself is very
rarely black and white.
There's a lot of room for interpretation.
There's a whole lot of guidance and nuance
that happens after the code is written.
And the tax court results are really
just one of those pieces of guidance.
Reading these court cases.
Really does give us fantastic
insight to the way the courts
have been leaning on some of these
topics that are in that gray area.
And when it comes to real estate,
there's plenty of gray area that we
love playing in with the tax code.
So getting these more recent kind
of thoughts from the tax court.
Getting this feedback, seeing
how they're viewing things.
This is invaluable.
What I have for you guys today.
Is two court cases that are both tax
court summary opinions from this summer.
So these are super recent
from July and August.
And both are related to real estate.
Microphone (Shure MV7)-2: The
first case that I want to walk you
guys through is from last month,
this came out August 20, 24.
This is TC summary, 2024 dash 17.
Eason V commissioner.
So this case was interesting because
it deals with a topic that comes up
pretty frequently when it comes to real
estate in two different capacities.
The first one being, if you pay for
one of those 40, 50, $60,000 real
estate guru courses, is it deductible?
And when is, or isn't it.
And the other part of the question
being, if you are new in real estate.
When does your business actually begin?
When are you open for business
where you can start writing off?
All of your costs that are incurred.
So those were the two big questions
that came up in this case.
So this summary opinion relates to a
couple who owned two rentals in 2016.
One of them, they maintained as a rental.
The second rental property
they had sold by June of 2016.
So at this point, they've got a
little bit of real estate experience.
They just actively got rid of
half of their real estate business
that existed, so to speak.
So they've got one rental left.
That same year.
The taxpayer in this case.
Lost his job.
Close to the beginning of the
year, the taxpayer lost his job.
And the couple started looking into other
ways they could supplement their income
and other opportunities to help make up.
For that last paycheck,
they were used to getting.
And one of the things they came
across was real estate investing.
So they were already a little bit
familiar with it and they had some
experience with rentals, but they
stumbled across an ad for a real estate
course or courses that you could take.
That would teach you how
to invest presumably.
In some capacity.
The court case does not
go into the details.
Of exactly what was covered in
that course or those courses.
But what it does say is that the taxpayer
and the spouse decided to invest in this
And they spend $41,934 on two different
courses from this same real estate.
Uh, quote, education provider.
So once they bought these
courses, The couple, then went
on to set up an S corporation.
So they established an
S Corp in July of 2016.
And they got some business cards.
They got some custom branded stationary.
But outside of that, Nothing
else really happened.
So there was no additional
purchases of real estate.
There were no proven efforts at marketing.
For a real estate.
There was no proven efforts at
advertising that they were in
the market to buy real estate.
Really not a whole lot else happened
after they set up this S corporation
and bought some business cards.
Also worth noting.
Is that by 2018.
So within a year and a half from when they
purchased these large expensive courses.
The company through whom
they had bought the courses.
Went out of business.
So another piece to this
specific case that was taken
into account by the tax court.
Was the fact that this couple
did anticipate having this
ongoing support and resources.
And all of this training and the moon
and the sun and everything else gurus
promise you when you give them $40,000.
And by 2018.
None of it was there.
It had all disappeared.
The company went under and
they were now on their own.
Microphone (Shure MV7)-3:
So the year in question.
For this couple's court case is 2016.
So 2016 is the year when, as a
recap, they had one rental property.
They had sold off their other rental.
Husband lost his job and they paid
40,000 plus dollars to accompany
for real estate education.
They then set up an S corporation, got
some business cards and stationary.
And that was the extent of
the business operations.
in this case, there were
a few key considerations.
That were looked at.
The first consideration.
Is.
Under code section 1 62.
When is the taxpayer entitled to deduct?
An expense as a business expense
that is ordinary and necessary.
Like when is it rightfully
able to be deducted?
And a part of the wording
to that code section.
Is that it relates to ordinary or
necessary expenses paid or incurred?
During a tax year in quote,
carrying on any trader business.
Now a lot of businesses do not make
money for their first few years.
That's not uncommon.
A lot of businesses lose lots of
money for multiple years that does
not make or break whether or not
someone is operating a business.
However, in this case.
There was all of the expense with
none of the income, but also none of
the proven effort to generate income.
And none of the provable attempts.
To actually continue to operate a
business after buying the course, setting
up the company, buying some business
cards that was the end of their effort.
So for 2016, This couple reported
over $40,000 of expenses as
deductible business expenses.
But when the court went back and
looked, they really had no proof.
That a good faith attempt was made.
To actually run or operate or
carry on a trader business.
Part of the reason why.
Is that it was never clearly defined
what this couple's business was.
So this makes things
a lot trickier, right?
If someone is opening a bakery, it's
pretty clear that as of the time
their doors are open and they've
got a case filled with macaroons.
They are open as a bakery.
That is what they're
offering to the public.
We had no defining information on what
this couple's business was, except
for something related to real estate.
the only.
Defining information, the couple gave
about their S-corp and why it was set
up and what they were going to use it
for is that they said that they quote,
formed it to provide advice and guidance
to real estate owners and investors.
The court went on to note that
although the specific services that
they intended to offer were unclear.
That, whatever it was,
they were going to offer.
did not require, or they had not
applied for, or received any kind of
state or local or federal licenses,
business license, et cetera.
So just a quick recap.
We've got a couple who've
owned, two rental properties.
They've currently got one.
They just paid $40,000 for
a course on real estate.
They set up an S-corp literally the same
month that they paid for that course.
And then told the court, the
purpose of that S corporation was
to provide guidance and advice to
real estate owners and investors.
So, this is just a side
note, little sidebar here.
That there are more people doing this.
Then I think a lot of people realize.
This is a couple who paid for a
real estate course, and then we're
turning around and what their stated.
Plan was for their corporation, was
to teach other real estate investors.
And guide them on their real estate.
The only experience they had
was two rentals and having just
paid $40,000 to someone else.
So an interesting overlap that just adds
a little bit of warning to be careful
and actually look into the background.
Of people offering these courses and
what they are benefiting from it.
And if them.
Offering this course and selling
you this course is making them more
money than their actual real estate
dealings, or if they don't actually have
experience in these areas of real estate.
And just be, just be careful.
So at the end of the day, The court
looked at all of these pieces of
information and they determined that
this couple did not ever open a business.
They had never put forth a valid attempt.
Two.
Really operate any kind of business.
There was no continuing
ongoing operations.
It never even really started.
There was never any defined factor
of what it was except for providing
general advice and guidance to others.
But they hadn't marketed that or
tried to sell that or anything else.
So on this TC summary, 20, 24 17, the
court disallowed, all of that expense.
Because it wasn't considered
a valid business expense.
So the moral of this case and this story.
Is that just paying for something to
learn how to do something or to learn
about something does not automatically
mean it will be tax deductible.
Especially if you either have not.
Started a business in that industry.
And this is related to it.
Or if you never do, if you never get
to that point, it's even less likely
that it's going to be deductible.
So just be cautious before
spending large amounts.
On potential businesses, right?
On something that you are hoping
to open a business doing, because
it might not be deductible.
And the secondary caution takeaway
is be careful of who you are paying
for education and advising and look
into their background because these
guys were going to sell education.
The same month they had just
paid to learn the information.
So just be careful.
The next case from this summer.
I really liked reading.
And this was from July of 2024.
This is TC opinion, 2024 dash 13.
And this is for this
and more V commissioner.
This case related to.
Short-term rental.
So here.
Is the interesting dynamic of this case.
Is that it was argued.
Based on the premise of real
estate professional status.
And it probably shouldn't have been.
So in this case for a dozen more
married, couple decide in 2020 that
they are building a carriage house.
In the back of their property.
They had actually obtained permits
for this a couple of years earlier,
but 2020 is the year that they finally
get to move forward with this project.
And start constructing
this carriage house.
Now, both the taxpayer and
the spouse work, full-time
at least 40 hour a week jobs.
The taxpayer makes just
under 80,000 a year.
The spouse makes just over 80,000 a year.
So this puts their overall income.
Well above the amount where you can
deduct some level of passive losses.
Unless you're a real estate professional.
Or unless you meet the
short-term rental loophole.
So during 2020.
They start building this carriage
house and the taxpayer spent a lot of
time doing a lot of the work himself.
Microphone (Shure MV7)-4: So he
would work full time and then
per his testimony, he would spend
all of his evenings and weekends.
Working on this carriage house.
He did also say that he hired
out any of the work that he
wasn't able to do himself.
But he said he spent well
over 2,500 hours that year.
Working on and to building
this carriage house.
So here's where things go sideways.
So this couple completes this carriage
house in 2020, they put it in service
in October as a short-term rental.
And for the 2020 tax year, they deduct
a schedule II loss of just over $22,000.
So.
Their return gets looked at.
It goes under audit and ends up in court.
And here were the key
things that were considered.
The first being, if this loss
was valid to be deducted.
But the only consideration was,
if this loss was able to be
deductible as a non-passive loss.
Based on the premise of the taxpayer being
a qualified real estate professional.
Meaning they spend more
than half of their time.
On this real property trader business.
The court felt that was not super likely.
Even though the taxpayer
testified, he spent more than
2,500 hours on this carriage house.
He had no proof other than this testimony.
And they just didn't find it super likely.
That he was working even more on this one
carriage house and building this property.
Then he was at his full-time job.
In addition to this.
In October when they put this
property in service as a short-term
rental, they immediately listed
it with a management company.
And that management
company handled everything.
the cleaning, the tenant
screening, all of it.
So not only was their question to the
amount of hours spent during the build.
But then once it was operational,
they immediately handed off all
of the day-to-day management
and time to someone else.
So in this case, this loss
was determined to be passive.
And the deductability of
that loss was disallowed.
Due to their income level.
Okay.
Here's what's really
interesting to me with this.
We don't have all of the details.
But based on what we know.
This was a short-term rental
and this taxpayer did spend a
lot of time on this property.
Now, once it wasn't service,
they were no longer managing it.
But I think it's incredibly interesting.
That the other options for it being
non passive, weren't brought up.
I want everyone to bookmark this case.
And the next time you have
a CPA or tax professional.
When you talk to them.
And they tell you that rental losses
are going to be passive, unless
someone's a real estate professional.
Or unless the rental goes on, schedule C.
I want you to send them this case.
Because this is what happens.
When you try to take advantage of
something in real estate when it
comes to the tax code, but either
you or who you're working with.
I don't know what they're doing.
This is really nuanced.
There are more than one ways
for a rental to be non passive.
And in this case, we don't know
the average length of stay.
We know it was a short-term rental and we
know it was only rented for a few months.
So if it turned out that the average guest
stay was seven days or less, And if it
could be proved that even with management,
this taxpayer still met material
participation through one of the rules.
I feel like they would have
had a much better chance.
Of making that argument to be
able to deduct this loss in tax
court, then making the argument for
real estate professional status.
But that's not the argument
that the taxpayer made.
They argued that they qualified for reps.
They were not aware of this short-term
rental loophole or if they were, they
didn't think it would be the better route.
I don't know.
But for me looking at this as an outsider,
it was incredibly frustrating because
the first thought I had was there was
likely a much stronger argument for
them to be able to deduct that loss.
So, again, this was TC
summary opinion, 2024 dash 13.
And this is from July.
This was just put out.
And this is related to
a 2020 tax year return.
So this is all very recent.
And wasn't presented in a way that
was most likely going to be in the
best interest of getting to maintain
that non-passive rental loss.
Microphone (Shure MV7)-5: Like I
said, Lots of interesting tax court
cases this summer, or at least to me.
So I hope you guys found this
somewhat interesting or maybe learn
something new from these cases.
I will link to both of
these in the show notes.
If you want to read over them yourself.
And again, I can't reiterate this enough.
Reading through these court cases
is such a good way to learn.
More of the, between the lines guidance.
That relates to tax.
It is not all black and white.
And what is on the IRS website is only.
An interpretation of the actual tax law.
And it's not even substantial authority
that you could bring into a court case
like this and use to defend yourself.
You need to know the law, you need
to know the related other court cases
that you can lean on for precedent.
So super interesting area to familiarize
yourself with, again, I'll link below.
If you guys have questions,
pop into the Facebook groups,
those are linked below as well.
So as always, if you've enjoyed
this episode or if you know
someone who you think would enjoy
this, please share it with them.
And.
I will talk to you guys next week.
Mhm.