IRS would Not Allow a True Rental Loss Because of use of a Rental Management Agency

The most recent audit was for a client rental house which had been her prior residence. Because she was attached to her old home, which was out of state, she decided to use a real estate management firm to handle the renters and property.

The tax code separates income into ordinary income which allows for ordinary losses, and passive income which doesn't allow for losses until the assets are disposed of Rental properties are both passive and active but the code requires the taxpayer to be actively involved in some way which would not be the case if it were a rental partnership with passive investors.

The office auditor claimed that the client wasn't active enough to make it a true rental loss because she had used a management agency. We appealed to supervision, which is a waste of time because they review all audits anyway, and got the 30-day letter to pay or appeal to the Tax Court.

The client and I showed up in the Riverside Appeals Court again and we showed that the client had indeed, been actively involved along with the property manager.

This was disputed by the Revenue Officer quoting the strict rules of the code. He had done his homework on the code and our case before we met so it was a discussion of the code, not the dollars or items involved.

My client appealed it further and after signing extensions for the case later on, after one year from the original audit we won. It was a narrow victory and a warning to people renting property to amend the boilerplate property manager agreement to require owner approval on all repairs that are not incidental, and for the owner to review the application of the selected tenant for final approval.

* Phillip B Chute is an Enrolled Agent, tested, licensed, and appointed by the IRS directly. He has prepared or supervised over 25,000 tax returns over 30 years.