Despite Issues With Records, Taxpayer Found to Be a Real Estate Professional

The key factor to sustaining a taxpayer’s claim to be a real estate professional in cases before the Tax Court generally comes down to whether the taxpayer has sufficient and reliable records to back up their activity.  In the case of Birdsong v. Commissioner, TC Memo 2018-148 the taxpayer’s records were found to be sufficient to sustain her contention that she was a real estate professional.

Roberta Birdsong managed the couple’s two rental properties, which consisted of four and five units each.  As the Court described her actions:

In 2014 petitioner wife was the sole party actively involved in the day-to-day management of their rental properties. These tasks included, inter alia, cleaning common areas, collecting coins from washing machines, performing repairs at the properties, communicating with tenants, collecting and depositing rent, maintaining insurance policies, purchasing materials for the properties as needed, paying bills, and keeping books and records for tax accounting purposes. She occasionally hired a contractor (such as a handyman or plumber) to perform tasks she could not complete herself. When she hired a contractor, petitioner wife spent considerable time researching and contacting contractors, obtaining price quotes, and supervising repairs. Petitioner wife's property management duties also included inspecting units, preparing (painting and supervising contractors) units for rental, advertising vacated units, screening potential tenants, showing the units, and processing rental applications.

Roberta’s records, which were key to her victory, were described as follows:

Petitioner wife produced two spreadsheets detailing her rental management activities. The first spreadsheet reflects that petitioner wife logged 844.75 hours managing the rental properties in 2014; the second spreadsheet shows a total of 1,136.25 hours. The second spreadsheet includes previously omitted tasks such as investor hours and driving time between the rental properties and the hardware store and other locations pertinent to the management of the units. Petitioners used petitioner wife's calendar and receipts to reconstruct the time entries on both spreadsheets for the first half of 2014. For the second half of 2014, the time entries come from a contemporaneous log petitioner wife maintained on her phone on which she entered the date, location, time, and description of each task she performed. Petitioner wife supplied receipts and invoices that substantiate the hours she logged.

To qualify as a real estate professional, a taxpayer must show two things.  First, the taxpayer must show that he/she spent more than one-half of the personal services performed in a trade or business in a real property trade or business.[1]  The IRS conceded that Roberta did not perform personal services in any other trade or business, so she met the first qualification.

The second test requires Roberta to show that she spent at least 750 hours in such real property trades or businesses.[2]  The IRS contended that Roberta did not meet this requirement.  Although her records claimed to show she spent between 844.75 and 1,136.25 hours in the real property trades or businesses.  The IRS argued that Roberta’s logs did not meet the requirements because “they were not contemporaneous and contained inaccuracies.”

As the Court noted, a “ballpark estimate” will not be sufficient to allow a taxpayer to sustain a claim to be a real estate professional.  The Tax Court has previously used inaccuracies and a failure to prepare the documents at the time the services were performed to disregard the taxpayer’s records.

But the Tax Court in this case did not agree with the IRS that Roberta’s records should be disregarded.  The opinion notes:

Petitioners testified credibly and in detail about petitioner wife’s active and extensive management of their rental properties. Furthermore, petitioners presented detailed spreadsheets that reflected petitioner wife's rental management activities exceeded the 750-hour requirement. We find petitioners' narrative summary and thorough time logs convincing because petitioners owned numerous rental units that petitioner wife operated alone. See Hailstock v. Commissioner, at *21 (holding that the taxpayer's credible testimony regarding time spent operating multiple properties alone satisfied the section 469(c)(2) requirements). Petitioners’ testimony is further buttressed by petitioner wife’s thorough time-keeping as well as the receipts and invoices petitioner wife produced to corroborate her time logs.

Two footnotes provide clues about how the Court came to this conclusion.  As is often the case, the Court’s impression of the honesty of a taxpayer is crucial when the taxpayer’s records are in question.  The opinion notes in a footnote:

We find petitioners to be honest, forthright, and credible. See Diaz v. Commissioner, 58 T.C. 560, 564 (1972) (observing that the process of distilling truth from the testimony of witnesses, whose demeanor we observe and whose credibility we evaluate, is the “daily grist of judicial life”).

But the Court warned the taxpayer that the IRS was correct that the fact that the records weren’t contemporaneous was a problem that she needs to correct in the future:

Although we caution petitioner wife to construct more strictly contemporaneous time logs for her future endeavors, we find her credible testimony and time logs to be a “reasonable means” of proof. See sec. 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988).

[1] IRC §469(c)(2)(i)

[2] IRC §469(c)(2)(ii)