Julie A. Oderio, TC Memo 2014-39
The Tax Court recently ruled that an individual who filed a separate return could not rely on her husband’s activities as a real estate professional to prevent her rental loss from being disallowed as a passive activity loss (PAL) under Internal Revenue Code (“IRC”) Section 469.
The PAL disallowance rules apply to any trade or business in which you do not materially participate. You are treated as materially participating in an activity if you meet at least one of the seven tests in Regulation § 1.469-5T. In determining whether any of the seven tests are satisfied, the participation of your spouse is considered.
In general, any rental activity is, per se, a passive activity regardless of your participation in the activity. However, there are exceptions to the per se rule.
Under IRC Section 469(c)(7), per se rule for rental activities doesn't apply to a qualifying real estate professional. You qualify as such for a particular tax year if: (1) more than half of the personal services that you performed during that year are performed in real property trades or businesses in which you materially participate; and (2) you perform more than 750 hours of services during that tax year in real property trades or businesses in which you materially participate. In a previous blog, we explained in more detail how to qualify as a real estate professional.
In the case of a joint return, the requirements for qualification as a real estate professional are satisfied if, and only if, either you or your spouse separately satisfies the requirements under IRC Section 469(h).
The regulations contain similar rules. For example, under Regulation § 1.469-9(e), if you are a qualifying taxpayer your rental real estate activity is exempt from per se passive activity loss treatment. You are considered a qualifying taxpayer if you own at least one interest in rental real estate and meet the requirements of Regulation § 1.469-9(c), including satisfying the real estate professional requirements.
If you and your spouse are filing a joint return, you are considered qualifying taxpayers only if one of you separately satisfies both requirements of IRC Section 469(c)(7)(B). In determining the real property trades or businesses in which you as a married taxpayer materially participates (but not for any other purpose under Regulation § 1.469-9(c)), work performed by your spouse in a trade or business is treated as work performed by the taxpayer under Regulation § 1.469-5T(f)(3), regardless of whether you are filing a joint return for the year.
Julie A. Oderio (“Oderio”), was married to and lived with Jason Oderio at all relevant times. During 2008, she worked full time as an employee for RREEF, a real estate investment company, and did not own more than a 5% interest in RREEF. Also in 2008, she had a rental property in San Jose, California.
Oderio filed her 2008 return as married filing separately. On it, she claimed a deduction for a rental loss of $29,583 with respect to the rental property.
The IRS issued Julie a deficiency notice disallowing the claimed rental loss deduction. She challenged the IRS's determination in Tax Court.
Oderio conceded that she did not separately satisfy the real estate professional requirements but argued that since her husband did, she therefore satisfied them as well. She relied on Regulation § 1.469-9(c)(4) and Regulation § 1.469-5T(f)(3), as support for her argument. She contended that, under those regultions, her spouse's efforts are attributable to her for purposes of satisfying the real estate professional requirements, regardless of whether she filed a joint return.
The Tax Court disagreed, pointing out that Regulation § 1.469-5T(f)(3) treats the participation of your spouse in an activity as participation by you for purposes of IRC Section 469 and its regulations without regard to whether your spouse files a joint return. Regulation § 1.469-9(c)(4) clarifies attribution as it relates to satisfying the requirements of IRC Section 469(c)(7)(B).
The Tax Court said that the parenthetical in Regulation § 1.469-9(c)(4) limits the use of spousal attribution to the material participation requirements of that section for purposes of satisfying the real estate professional rules. Thus, while the regulations Oderio cited do allow for spousal attribution with respect to the material participation requirements of the real estate professional rules, they do not allow for spousal attribution for purposes of meeting its other requirements, namely, that a taxpayer perform more than one half of their personal services and more than 750 hours in real estate trades or businesses.
The IRS argued that because Oderio did not file a joint return with her spouse, she could not satisfy the real estate professional requirements through her spouse and had to separately satisfy them herself. The Tax Court agreed with the IRS that the real estate professional requirement states that a taxpayer must separately satisfy its requirements. Its flush language provides an exception to this general rule in the case of a joint return. In that special circumstance, a taxpayer's rental activity is not treated as a per se passive activity if either spouse meets its requirements. Under the statutory canon of construction "expressio unius est exclusio alterius," if a statute provides specific exceptions to a general rule, one may infer that Congress intended to exclude any further exceptions in the absence of contrary legislative intent. Oderio cited no contrary legislative intent, nor did the Court find any. Consequently, the Court inferred that Congress did not intend any further exceptions to the real estate professional requirements and it follows that taxpayers not filing a joint return must separately abide by it.
Accordingly, the Tax Court held that a married taxpayer filing separately must separately satisfy the requirements of IRC Section 469(c)(7)(B) to avoid per se passive activity loss treatment. Because Oderio conceded that she did not separately meet all the real estate professional requirements, the Tax Court sustained IRS's determination disallowing the rental loss deduction.
The intersection where taxes meet real estate often has many confusing laws and long-winded court holdings. Though this one is pretty straight forward, it centers around an incorrect assumption that many taxpayers can easily make. The tax advisors at Drucker & Scaccetti have extensive experience with the Tax Code as it relates to real estate. We have decades of experience in taxation for real estate owners and developers and can apply it nationwide.
Call on us if you have a question about your real estate property and how to apply the IRC to it. We are always prepared to help you with this or any other tax-related matter.