Ezra Dyckman and Daniel W. Stahl

The stakes can be huge when it comes to qualifying as a “real estate professional.” It can be the difference between (i) being able to use losses from real estate activities to offset salary or other ordinary income or (ii) having passive activity losses from real estate activities that may be useless. Unfortunately, qualification as a real estate professional is determined based on a very fact-specific test, and is often difficult for taxpayers to substantiate. A recent case is noteworthy in that a part-time stockbroker was able to successfully convince the Tax Court that she qualified as a real estate professional.


Under Internal Revenue Code section 469, an individual may net losses from passive activities against income from passive activities, but is precluded from using a net passive activity loss to offset active income. A “passive” activity, in general, is an activity that involves the conduct of a trade or business, and in which the taxpayer does not “materially” participate. The Treasury Regulations provide that individuals will satisfy the material participation requirement with respect to an activity if they meet any one of seven tests. Rental real estate activities are generally per se passive, regardless of whether an individual materially participates. However, this rule does not apply to a “real estate professional,” i.e., an individual (1) for whom more than half of his personal services performed in trades or businesses are performed in real property trades or businesses in which he materially participates and (2) who performs more than 750 hours of services during the taxable year in real property trades or businesses in which he materially participates. Therefore, losses of an individual from a rental real estate activity will not be passive if both (x) the individual is a real estate professional and (y) the individual materially participates in that activity. For purposes of determining material participation, each interest in rental real estate is treated as a separate activity unless the individual makes an election to have them all treated as a single activity.

‘Windham v. Commissioner’

In the recent case of Windham v. Commissioner (T.C. Memo 2017-68), the Tax Court considered a woman who worked as a part-time stockbroker for Wells Fargo, working for 2.5 hours per day when the stock market was open, as well as during business lunches and dinners. In addition, she owned 12 rental real estate properties that she managed by herself, performing activities such as vetting tenants, collecting rent, dealing with contractors and repairmen, and recordkeeping. The taxpayer reported a $307,933 loss from her rental properties in 2010, which she used to offset her Wells Fargo wage income. The IRS issued a notice of deficiency asserting that this loss was passive and could not be used to offset her wage income. The taxpayer then filed a petition with the Tax Court. It appears that the IRS argued in the Tax Court proceedings that both (i) she was not a real estate professional and (ii) she did not materially participate in her rental activities. The Tax Court first addressed material participation. Since the taxpayer had not made an election to have her rental real estate activities grouped together, the Tax Court considered whether she met the threshold for material participation separately for each property. Still, the Tax Court held that for each of the rental properties she satisfied at least one of the following two tests for material participation in 2010: (i) that the individual participates for more than 100 hours and participates for more hours than any other individual or (ii) that the individual’s participation constitutes substantially all of the participation in the activity during the taxable year. The Tax Court then determined that she was a real estate professional, believing her testimony that (i) she had spent 889.25 hours in the rental real estate activities in which she materially participated (i.e., more than 750 hours) and (ii) these 889.25 hours were more than the hours that she had spent working as a stockbroker (600 hours in her office, plus an unquantified amount of time spent at business lunches and dinners). As a result, the Tax Court held that the taxpayer was entitled to use her rental real estate losses to offset her wage income in 2010.


The taxpayer in Windham v. Commissioner was found to have materially participated in each of her separate rental activities, and therefore it was irrelevant that she had not made the election to group together all of her rental real estate activities. However, it is often the case that an individual with multiple rental real estate activities does not meet the threshold for material participation in any one activity, but would meet the threshold if they are aggregated together. Unfortunately, it is a common mistake for individuals to fail to make the election out of simple neglect. Still, one should pay careful attention before making the election, as there are certain circumstances in which it may be best to not make the election (and once made, the election cannot be revoked). For example, suppose that an individual has income from interests in rental real estate, and losses from an interest in residential condominiums held for sale in which the individual does not materially participate. This individual may want the rental real estate income to be passive so as to have it be offset with the passive losses from the residential condominiums. Beyond this issue, Windham is a noteworthy case in that the taxpayer was able to convince the court that she met the test for qualifying as a real estate professional despite having a separate job as a stockbroker. In contrast, there are many other cases where courts have held the records held by the taxpayer were insufficient to substantiate the hours spent in real estate activities. The key in this case seems to have been that the Tax Court found the taxpayer’s testimony regarding her hours spent to be believable, based on the specific duties that she performed. It is hard to know exactly what message to take home from Windham, since it is unclear exactly how detailed the time records kept by the taxpayer were. What is clear though, is that individuals participating in rental real estate activities can greatly help themselves by keeping time records (preferably contemporaneous) that are as detailed as possible—and that the time for focusing on this is now, and not after the IRS starts an audit.

Ezra Dyckman and Daniel W. Stahl are partners in the law firm of Roberts & Holland.