Tax Blog

Real-time Record Keeping Helps with Passive Activity


A taxpayer and his spouse lost their argument in Tax Court and could not deduct passive activity losses (PALs) from several activities they are involved in. In court the taxpayers failed to shift burden of proof to the IRS, and were liable for the accuracy-related penalty.

The three activities the couple were involved in was a medical center, a ranch, and a rental real estate. The husband was a limited partner in the medical center, but claimed he materially participated in it because he provided more than 500 hours in services per year. The couple’s rental real estate was argued as not being passive because they were real estate professionals who provided at least 750 hours of service per year in the rental operation. In regards to the ranch, the couple claimed that they materially participated in their ranch activity under either personal services test or the facts and circumstances test.

This case is long and arduous for a blog posting, the take away summary is that without contemporaneous documentation of their activities, taxpayers are unlikely to be able to prove they materially participated in a passive activity. Real-time recordkeeping is essential, perhaps more so as digital tools make it easier to keep and maintain records, therefore, more is expected of taxpayers by the courts.

Closing, the taxpayers were also liable for the accuracy-related penalty because they did not prove that they relied on a tax professional in good faith. Although they hired a return preparer, they did not show that she was competent, and they did not present credible evidence of what, if any, records they provided to her.

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