Real Estate Professional Status and Rental Loss Deductions: Lessons From a Tax Court Loss
Many real estate investors assume that rental losses can automatically reduce taxes on wages, business income, or professional income. Federal tax law does not work that way. A recent Tax Court decision shows how rental losses can be completely disallowed when the real estate professional rules are not carefully followed.
The Case That Caught the Court’s Attention
In Mirch v. Commissioner, the taxpayers owned several rental properties and claimed substantial rental losses. They reported those losses as nonpassive, using them to offset income from a law practice. The IRS challenged the deductions, arguing that the taxpayer who managed the rentals did not qualify as a real estate professional.
The Tax Court agreed with the IRS after closely examining how the taxpayer spent her time and what work she actually performed. The outcome turned on facts, documentation, and the nature of the services performed during the year.
Why Time Records Were a Central Issue
To qualify as a real estate professional, a taxpayer must spend more than 750 hours during the year in real estate activities and must devote more than half of their total working time to those activities. In this case, the taxpayer attempted to meet those thresholds using reconstructed time summaries prepared after the year had ended.
The Court rejected those summaries. It placed significant weight on the lack of contemporaneous records, such as daily or weekly logs, calendars, or appointment records. General testimony about being heavily involved was not enough. Without reliable documentation, the Court found that the taxpayer failed to prove she met the required hour thresholds.
The Nature of the Work Also Mattered
Even if enough hours had been documented, the Court examined what the taxpayer actually did for the rental properties. Much of the claimed activity involved paying bills, reviewing bank statements, tracking expenses, and providing general oversight.
The Court concluded that these tasks were largely administrative or investor level activities. They did not rise to the level of operational involvement required to establish material participation. Simply owning properties and monitoring finances did not qualify as active real estate work under the tax law.
No Relief From Grouping the Properties
The taxpayers also failed to show that they had properly grouped their rental properties into a single activity. Without a valid grouping election, each rental property had to independently meet the material participation requirements. None of the properties satisfied those standards on their own, which further weakened the taxpayers’ position.
Key Tax Impacts for Rental Property Owners
- Rental losses remain passive unless strict real estate professional rules are met.
- Reconstructed time logs prepared after the year ends carry little weight.
- Administrative and financial oversight usually does not count as qualifying real estate work.
- Failure to make proper elections can cause each property to be tested separately.
The result in this case was severe. All rental losses were treated as passive, could not offset other income, and could not create a net operating loss. The IRS assessment was fully sustained.
Why This Matters Before Filing Your Return
Real estate professional status is one of the most heavily scrutinized positions in an IRS audit. Once the return is filed, missing records usually cannot be fixed. High income taxpayers and professionals with rental losses face increased audit risk in this area.
Proper planning before filing can help establish qualifying activities, implement practical time tracking systems, and evaluate whether grouping elections make sense for your situation.
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Final Takeaway
The Mirch case is a clear reminder that real estate professional status depends on facts, documentation, and the nature of the work performed. When done correctly, the tax benefits can be substantial. When done incorrectly, valuable deductions can disappear entirely.
