Are Real Estate Investors the New IRS Target?

It’s no secret that our federal government is looking for revenue wherever they can find it.

According to a recent report from the Treasury Inspector General for Tax Administration (TIGTA), more than half of tax papers with rental real estate property in 2001 did not report their income and losses correctly. To the tune $12.4 billion.

Since 1986, the IRS has limited the deductions of “Passive Activity Loss” for individuals making less than $100K adjusted gross income to $25,000. To qualify for this $25K, the individual must own at least a 10% share of the rental property.

Two exceptions to the rule apply to real estate professionals, and you must meet both requirements to claim losses beyond the $25K limit:

1.       The taxpayer must receive more than 50% of his/her income during the taxable year from the “personal services performed real property trades or businesses in which the taxpayer materially participates.”

2.       The taxpayer must “perform more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates.”

Based on their review of tax returns of taxpayers who took the real estate professional route, taxpayers were erroneous in their claims by $12.4 billion. The TIGTA’s findings resulted in new recommendations on the Schedule E form for Tax Year 2011.

When a taxpayer has income or loss from rental real estate and royalties, he or she must report this on the Schedule E (Supplemental Income and Loss) Page 1. The suggested changes will occur on Page 2, which is where you calculate passive and non-passive income or losses from partnerships, S corporations, estates, trusts or real estate mortgage investments (such as rental properties).

Basically, you will be required to share more information on your investments in Page 2 of Schedule E. The recommendations include:

1.       A common description of the property – single-family house, multi-family house, commercial property, personal use, vacation homes, land, royalties, or other). Currently, you only have to describe the type and location of the property (you get to choose your description). This recommended change will require you to select from a list of common terms mentioned above.

Analysis: The TIGTA report says that this will ease the audit process for classifiers because they can identify the “reasonableness of rental property expenses for a single-family home than a multi-family property.” What this means for you: You will have to keep more diligent records.

2.       Actual number of days the rental property was occupied by a tenant and the number of days it was used for personal purposes.

Analysis: The Fed is on the hunt for more money to ease their deficit. This means more scrutiny for real estate investors because this report recommends that the U.S. Treasury would increase $27.3 million in five years. The way they want to accomplish this is through more audits of real estate professionals and investors. They want to know what you are doing with your properties when you claim a loss. Again, you need to have your ducks in a row on your personal use versus tenant use.

For more on the TIGTA recommendations, read the full report here.

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