Friday, August 6, 2010

Guess me Out of the Ballpark

The case of Marcel Ajah (TC Summary Opinion 2010-90) is about the ultimate oxymoron - "passive activities".  The concept of passive activities embodied in Section 469 is a creature of the Tax Reform Act of 1986's attempt to drive a stake through the heart of the tax shelter vampires after the silver bullet of the at-risk rules under 465 had failed to eliminate them.  Oddly enough while the at-risk rules specifically excluded real estate, the passive activity rules specifically target it, by indicating that rental activities are per se passive.  This was a source of real aggravation to people who actively manage their own real estate.  In the 1990's there was a relaxation for people who spent most of their time in trades or businesses related to real estate.

In order to take advantage of the relief many taxpayers needed to make a special election to treat all their rental real estate activities as one activity.  Otherwise, the exception to the "per se" passive rule would do them no good unless they were "materially participating" in each of their properties.  Since the basic standard of material participation is 500 hours per year (there is a separate 750 hour requirement to be recognized as being in a real estate trade or business), even very hard working people can't materially participate in more than a couple.  There are wonderful regulations that explain to you how to go about grouping your activities to keep track of whether you are meeting the material participation standard.

Marcel Ajah illustrates the Achilles heel of the whole system, though.  Most people don't keep very good track of how they spend their time.  The regulations do not specify a particular method, but the cases beginning with William Goshorn in 1993 (TCM 1993-578) seem to characterize any method that taxpayers use to reconstruct their time as being a "post-event ballpark guesstimate".  "Ballpark guesstimate" which seems to me to be a fairly robust concept is apparently limited to estimates of time spent to satisfy material participation requirements. 

Marcel Ajah and his wife owned two rental properties, the commercial building out of which he operated his medical practice in Jamaica, NY and a single family residence in Baltimore MD.  They claimed that Mrs. Ajah qualified as a real estate professional.  They lost the case on two grounds.

Mrs. Ajah argues that she qualifies as a real estate professional for the year in issue. She relies upon certificates from the Long Island Board of Realtors, Inc., the Multiple Listing Service of Long Island, Inc., and the State of New York Department of State Division of Licensing Services. These certificates reflect, respectively, that for 2005 she pledged to adhere to the realtor code of ethics, had completed required courses on broker rules and regulations, and was licensed as a real estate broker. Mrs. Ajah testified that she worked at least 20 hours a week for the 52 weeks of 2005 on the two rental properties. Mrs. Ajah did not offer any evidence as to the number of hours she worked as an attorney in 2005. No contemporaneous record, calendar, appointment book, or any other method of recording time spent between rental real estate activities and activities as an attorney was provided. Thus, the Court is unable to conclude that more than one-half of Mrs. Ajah's personal services were devoted to the rental properties.


We conclude that Mrs. Ajah's method of calculating her time spent participating in the rental activities constitutes an impermissible “ballpark guesstimate”.

The other problem was that the Ajahs had not filed the election to aggregate meaning that she would have to meet the 750 hour requirement on each of the properties which wasn't even in her ballpark.

Earlier in the year Donald Trask (TCM 2010-78) who owned 33 rental properties managed to convince the tax court that he spent more than 750 hours working on them, but he was hung by the failure to make the election to aggregate.  The fact that he had aggregated the properties in reporting his income and loss was not sufficient.

It is not always advantageous for the real estate professionals to make the election, but it is definitely something that should be looked at.  There is no question that if you are posting negative numbers from real estate or side businesses on your returns you should be doing something to keep a current record of your time.  My own experience working with appeals on this issue is that the Service will characterize almost any reconstruction of time spent as being a "ballpark guesstimate".  And they aren't handing out any peanuts or cracker jacks,

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