National Office Memorandum Holds That Licensed Mortgage Brokers Are Not Performing Services that Qualify as Real Estate Trade or Business

In order to qualify for “real estate professional” status for the taxpayer’s rental properties, the taxpayer must meet certain participation requirements in a real estate trade or business.

IRC §469(c)(7)(C) has the definition of what constitutes a real estate trade or business.  That section reads as follows:

Real property trade or business. For purposes of this paragraph , the term “real property trade or business” means any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.

In Chief Counsel Advice 201504010 the question posed looked at the issue of what is a “brokerage” trade or business, specifically considering two separate categories.  Those two were:

  • Real estate agent
  • Mortgage broker

The advice concludes, with virtually no analysis, that a real estate agent, even if not licensed as a real estate broker by the state in which he/she resides (which is normally the case), nevertheless is performing brokerage services.  As some may remember, the IRS had tried unsuccessfully years ago to argue that real estate agents who were not licensed brokers could not be real estate agents.

However, the Courts have held that the issue of technical state law licensing terms say is not relevant in applying federal statutes.  Real estate agent may (and most often do) work under a licensed brokerage firm, but they end up performing what is a real property brokerage service.

However, the IRS uses this analysis to determine that mortgage brokers are not engaged in real estate brokerage, even though they may be licensed under state law as performing a real estate brokerage business.

The memorandum notes that:

Although Congress initially included "finance operations" in the list of qualifying real property trade or business activities in an earlier, unenacted version of what would become § 469(c)(7)(C), (H.R. 3732, 101st Cong. (2d Sess. 1989), S. 2384, 101st Cong. (1989-90)), "finance operations" was removed from the final bill. H.R. 2264, 103d Cong. (1993) (enacted). It is therefore reasonable to infer that Congress did not intend for financing activities to constitute a real property trade or business and that financing activities should not be included in the definition of "real property brokerage."

The analysis then goes on to conclude that common usage of the term real estate brokerage does not include handling the financing aspects.

Webster's Dictionary defines "real estate" as "property consisting of buildings and land; the business of selling land and buildings," and defines "brokerage" as "the business of a broker" or the "broker's fee or commission."1 Webster's defines a "broker" as "a person who helps other people… to buy and sell property."2 Accordingly, the common and ordinary construction of "real property brokerage" for purposes of § 469(c)(7)(C) involves bringing together buyers and sellers of real property. This definition of "real property brokerage" does not include the brokerage of financial instruments.

Therefore the "financing" of real property such as by bringing together lenders and borrowers is not a real property brokerage trade or business within the meaning of §469(c)(7)(C). Thus, consistent with the legislative history of § 469(c)(7)(C), and under the common and ordinary construction of "real property brokerage," X (the real estate agent in the IRS example) is engaged in a real property trade or business within the meaning of § 469(c)(7)(C), and Y (the mortgage broker in the IRS example) is not.

The ruling is merely the opinion of the IRS National Office and is not itself directly binding on taxpayers or the Courts.  However, the document may very well suggest a position agents may end up taking should an examination begin for such individuals.