Real Estate Agent Didn’t Materially Participate in Rental Activity

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Wednesday, April 2, 2014 from Bloomberg Daily Tax Report

Tax Decisions & Rulings – Real Estate
Federal Court: Real Estate Agent Didn’t Materially Participate in Rental Activity

The U.S. District Court for the Northern District of California held that a real estate agent’s losses from rental properties were subject to passive loss limitations, because the real estate agent couldn’t prove that she materially participated in each rental real estate activity (Gragg v. United States, N.D. Cal., 4:12-cv-03813, 3/31/14).

Judge Yvonne Gonzalez Rogers, in granting summary judgment to the government and denying the taxpayers’ cross-motion for summary judgment on March 31, said Section 469(c)(7) and its related regulations didn’t excuse real estate professionals “from the obligation of showing material participation in each real estate activity before deducting otherwise passive losses from that activity.” The Internal Revenue Service disallowed losses in excess of the passive loss limitation claimed by Charlesand Delores Gragg on their 2006 and 2007 tax returns from two rental properties the couple owned in Pleasanton, Calif., resulting in deficiencies of $14,874 for 2006 and $43,499 for 2007.

Rental Activities Separate

The Graggs paid the additional tax assessed plus interest and penalties and sued for a refund, arguing that Delores’s “full-time occupation as a real estate professional generally relieves her and her husband from having to show material participation in their rental real estate activities before deducting losses from those activities against their income.” Rogers said that Treasury Regulations Section 1.469-9(e)(3)(i) was directly applicable and provided that Delores’s work in a real estate occupation and the ownership of rental real estate were separate and distinct activities that may not be grouped together. The Graggs’ “construction of section 469 would contravene the regulation’s guidance by treating Mrs. Gragg’s rental real estate activities as part of her other activities, namely, her activity of performing personal services as a real estate agent,” Rogers said.

Single Activity Election

Rogers also found that the two rental properties must each be treated as separate activities, because the Graggs failed to elect to treat all interests in rental real estate as one activity under Section 469(c)(7)(A)(ii). Delores’s “personal interests in her rental real estate properties are not coupled with or dependent upon the personal services she renders to clients as a real estate agent. The mere fact that both relate to real estate does not suffice to establish Mrs. Gragg’s material participation in each separate activity in which she participated,” Rogers said. Rogers cited Perez v. Commissioner, T.C. Memo. 2010-232, 2010 BL 251920 (2010), as persuasive, saying the U.S. Tax Court case squarely addressed “the question now at bar.” In that case the Tax Court found that a mortgage broker didn’t meet the material participation requirements to deduct losses from her three rental properties in excess of the passive loss limitations.

The Graggs were represented by the Jaurigue Law Group in San Jose, Calif., and the Law Offices of Robert L. Goldstein in San Francisco. The U.S. Attorney’s Office in San Francisco represented the government.

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