I can't tell you how many events/meetings/sales pitches I've attended, where the speaker is talking about the wonders of depreciation deductions. Typically they'll show you that you will be upside down on your monthly payments, but that is a good thing because. . . tadah, you get to take the depreciation write off on the property.
Being a tax dweeb, I always scratch my head and wonder, what about the passive activity loss limitations?
The taxpayers in HARMON v. COMMISSIONER are probably scratching their heads as well.
In 2001, the Harmon's incurred a 68K loss on their rental property. Logically enough, they fully deducted that loss on their return. One small problem though.
Under something called the passive activity loss rules, losses from a passive activity are not allowed unless some conditions are met. The one that a lot of us are famaliar with is that $25,000 of the losses are allowed each year, with that amount dropping by 50 cents for every dollar of adjusted gross income over $100,000.
A more favorable status is something called a real estate professional. Under the code someone could be a professional if they meet a 2 prong test:
(i) more than one-half of the personal services performed in trades or businesses by the taxpayer during such taxable year are performed in real property trades or businesses in which the taxpayer materially participates, and
(ii) such taxpayer performs more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates.
The above time requirements really show that it isn't just attorneys who to tend to work 48 hour days, with full documentation, but high net worth types as well.
The reason I say that is the taxpayer must ultimately show that not only did they devote 750 hours to real estate work, but also that greater than 50% of the services provided by the taxpayer must be in the field of real estate. This really strains the credibility when the taxpayer is alreading working for someone else 40 hours a week.
That is exactly what happened in this case, not ony that, but the taxpayer already had 2 other jobs; one was a typical 40 hour work week job, the other was an adjunct professor at a business school. Hopefully she wasn't teaching ethics at the business school, as she testified that she only worked 8 hours a week, even though her payroll records showed she put in 2,080 hours.
You kind of have to wonder if she let her bosses know she was only working 8 hours a week.
I'll let you guess how this case turned out.
Bottom line, do not count on those real estate losses actually helping you lower your taxes unless you aren't making enough to really need the deductions, or you are legitimately devoting a lot of your time to your real estate investments.
