The days of the kinder, gentler IRS are over. The management of the IRS has purportedly told the auditors to "audit more rigorously and go collect some money!"

That translates to selecting more tax returns for audit and testing the interpretations of IRS Code and Regulations, and not in our favor. One issue under fire right now is the definition of "Real Estate Professional."

Real Estate Agent = Real Estate Professional?

A Real Estate Professional, in the eyes of the IRS, is someone who spends more time in real estate activities than in any other job, trade or business and who spends at least 750 hours per year in those activities.

The Real Estate Professional designation becomes especially important if you own real estate investments. Generally, if you make less than $100,000, you can't take more than $25,000 in real estate losses against that income. If you make more than $150,000, you can't take any real estate losses. The amount you can take phases out if your income is between $100,000 and $150,000.

But, if you're a Real Estate Professional, you can take all of your real estate loss against your other income, no matter how much the loss was and how much your income was.

Tax Strategy Change

If you came to me as a client three years ago, complaining about paying too much in taxes, I would have told you to buy more real estate investment property. The passive loss offsets from items such as depreciation can be used to offset your other income, no matter how much the loss is and no matter how much in the income is. You had no income or loss limitation because you are a real estate professional.

Now, in a handful of IRS audits in California, the auditors have taken the position that a real estate agent is not a real estate professional. That's because the real estate activity definition states that "brokering" the sale, purchase or lease of a property qualified as real estate activity for the time requirements. The IRS is taking the position, at least in these two cases, that you must be a licensed broker in order to broker a deal.

Needless to say, the agents hit by this audit decision (and all the extra tax, interest and penalties) are fighting it all the way to Tax Court. It's hard to say which way this will go. If the IRS prevails, look for a lot more IRS audits of real estate agents, particularly if the agent also owns real estate investments. Hopefully, the Tax Court will send the IRS packing and we can all breathe a sign of relief.

To find out more about this and other vital tax issues, please check TaxLoopholes.com for the daily blog updates.

Published: February 21, 2008

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Diane Kennedy, the nation's pre-eminent tax strategist, is owner of Diane Kennedy & Associates, a leading tax strategy and accounting firm and founder of TaxLoopholes. She is the author of The Wall Street Journal and Business Week bestsellers, Loopholes of the Rich and Real Estate Loopholes, and co-author of The Insider's Guide to Real Estate Investing Loopholes, The Insider's Guide to Making Money in Real Estate, and TaxLoopholes for eBay Sellers. Register for free Tax Strategy updates and e-Newsletters delivered via email from TaxLoopholes.com. You will be updated on current tax law changes as well as proactive tax strategies the wealthy use plus news regarding Diane Kennedy.