The Tax Court accepted the taxpayer’s position that he was a real estate professional in the case of Zarrinnegar, et al v. Commissioner, TC Memo 2017-34. And Dr. Zarrinnegar prevailed in this case despite working in his own dental practice with his spouse, Dr. Dini.
To be classified as a real estate professional a taxpayer must meet two tests. First, the taxpayer must have over 750 hours of services in real property trade or businesses in which he actively participates and more than one-half of the personal services performed in trades or businesses in which the taxpayer participates must be in real property trades or businesses. [IRC §469(c)(7)]
Merely being a real estate professional isn’t enough to allow a taxpayer to deduct losses from rental activities. While they are no longer automatically treated as passive activities, the taxpayer must still demonstrate material participation in the activities.
The IRS conceded that if Dr. Zarrinnegar is a real estate professional he would qualify as materially participating under the “substantially all” test found at Reg. §1.469-5T(a)(2) since his activities in this case “constitutes substantially all of the participation in such activity of all individuals (including individuals who are not owners of interests in the activity) for such year.”
Since Dr. Zarrinnegar also was working in his practice, he faced skepticism from the IRS both with regard to whether he had 750 hours to participate in the activities and whether his hours in real estate activities were more than his hours in the dental practice.
The doctors worked alternating shifts in their practice, as explained by the opinion:
Petitioners are both dentists. During the years at issue they worked at their joint dental practice in shifts. Petitioner wife worked Mondays, Wednesdays, Thursdays, and Fridays from 9 a.m. until 2:30 p.m. and some Saturdays from 8 a.m. until 12 p.m. Petitioner husband worked at the dental practice Mondays, Wednesdays, Thursdays, and Fridays from 2:30 p.m. until 6 p.m.
Dr. Dini did not work in the rental activities, but rather all of the activities were performed by Dr. Zarrinnegar. As the court explained:
Petitioner husband spent hundreds of hours on brokerage-related activities, including brokers' tours, listing searches, open houses, property viewings, and client meetings. He also spent significant time each year managing petitioners' four rental properties. All told, petitioner-husband spent over 1,000 hours on the real estate business during each year at issue.
The Court concluded that Dr. Zarrinnegar worked that many hours based both on the quality of his records and credible testimony offered in support of the hours he spent:
To establish the hours petitioner husband spent each year on his real estate business, petitioners offered petitioner husband’s testimony and logs of hours for 2010, 2011, and 2012; each log showed that petitioner husband spent more than 1,000 hours per year on real estate activities. Petitioner husband testified credibly that the logs had been prepared contemporaneously. He also testified credibly and at great length about the logs’ contents; he was able to recall extensive details relating to the entries. Petitioners also offered the testimony of several other witnesses, including petitioner wife. All this testimony was credible and tended to corroborate petitioner husband’s logs and testimony. We therefore find that petitioner husband worked more than 1,000 hours per year at the real estate business.
But establishing his hours spent in real estate was only one part of the test—Dr. Zarrinnegar had to establish that he worked at least one less hour in the dental practice. But the Court found he had established that point as well:
We also find, on the basis of petitioners’ credible testimony, that petitioner husband worked at the dental practice Mondays, Wednesdays, Thursdays, and Fridays from 2:30 p.m. until 6 p.m., for a total of 14 hours per week (that is, approximately 728 hours per year, if petitioner husband worked every week). Petitioner wife worked at the dental practice Mondays, Wednesdays, Thursdays, and Fridays from 9 a.m. to 2:30 p.m. and some Saturdays from 8 a.m. until 12 p.m. Petitioner husband’s logs of real estate activities, and the testimony of the various witnesses about the time petitioner husband spent on real estate activities, tend to corroborate—at least indirectly—petitioner husband’s limited schedule at the dental practice in the light of the time he was spending in pursuit of his real estate business. After careful review of all the evidence, giving due account to the credibility of petitioners and the other witnesses, we are persuaded that petitioner husband worked fewer than 1,000 hours at the dental practice in each year at issue.
The fact that this return got pulled for examination isn’t surprising—there have been far more cases in court where taxpayers with other occupations have failed to show they were real estate professionals because they could not credibly establish that they had worked more hours in real estate than in their other job.
In this case, though, the taxpayers were able to clear that hurdle—and the reason is largely because Dr. Zarrinnegar was a believable witness, backed up by consistent records.