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Part III: Passive Activity Loss Limitation and Real Estate Professional Tax Rules

Published: June 21st, 2017

Stephen R. Looney

In Part III of the series, we continue to look at the passive activity loss limitation rules to clarify what constitutes a real estate professional for the purpose of rental property losses. In Part I and Part II of this series, the court found the taxpayers did not qualify as real estate professionals. However, Zarrinnegar v. Comm’r is one of the few cases in which a taxpayer has been successful in showing their qualification as a real estate professional.

Zarrinnegar v. Comm’r

In Zarrinnegar,[1] the Tax Court largely upheld the IRS’s disallowance of a couple’s business expense deductions for their dental practice, but found that the IRS improperly disallowed rental losses, noting that the husband qualified as a real estate professional under Section 469(c)(7). The Zarrinnegar case is one of the few cases in which a Taxpayer has been successful in showing that he or she qualifies as a real estate professional.

Under the facts of Zarrinnegar, both the husband and wife were dentists in a joint dental practice, where the wife worked Mondays, Wednesdays, Thursdays and Fridays from 9:00 a.m. until 2:30 p.m. and some Saturdays from 8:00 a.m. until 12:00 p.m., and the husband worked Mondays, Wednesdays, Thursdays and Fridays from 2:30 p.m. until 6:00 p.m.

During the years in issue, the Taxpayer’s real estate business consisted of the husband’s activity as a real estate broker and his management of four rental properties that they owned. The husband spent hundreds of hours on broker-related activities, including broker’s tours, listing searches, open houses, property viewing and client meetings. He also spent significant time each year managing the four rental properties. The court found that the Taxpayer-husband spent over 1,000 hours on his real estate business during each year at issue.

Because the IRS conceded that the husband’s participation in each of his real estate activities for each year at issue constituted substantially all of the participation in such activity[2] of all individuals, the court found that the husband satisfied the material participation requirement. Consequently, the sole question was whether the husband qualified as a real estate professional.

The court stated that the husband’s logs for 2010, 2011 and 2012 showed that he spent more than 1,000 hours per year on real estate activities. The court also found that the Taxpayer-husband testified credibly that the logs had been prepared contemporaneously and stated that the Taxpayer-husband was able to recall extensive details relating to the entries. The court found that the testimony from other parties was also credible and tended to corroborate the Taxpayer’s logs and testimony, and as such, found that the Taxpayer-husband worked more than 1,000 hours per year on his real estate business.

The Court also found Taxpayer’s testimony credible on the number of hours he worked in the dental practice. If the Taxpayer-husband worked every week on Mondays, Wednesdays, Thursdays and Fridays from 2:30 p.m. until 6:00 p.m., the amount devoted to his dental practice would total 728 hours per year. Consequently, the Court was persuaded that the Taxpayer worked fewer than 1,000 hours at the dental practice in each of the years in issue, and as such, qualified as a real estate professional and was permitted to deduct the losses generated by the rental properties.

About the Author:
Stephen R. Looney is the chair of the Tax department at Dean Mead in Orlando. He represents clients in a variety of business and tax matters including entity formation (S and C corporations, partnerships, and LLCs), acquisitions, dispositions, redemptions, liquidations, reorganizations, tax-free exchanges of real estate and tax controversies. His clients include closely held businesses, with an emphasis on medical and other professional services practices. He is a member of the Board of Trustees of the Southern Federal Tax Institute, as well as former Chair of the S Corporations Committee of the American Bar Association’s Tax Section. He is Board Certified in Tax Law by the Florida Bar, as well as being a Certified Public Accountant (CPA). He may be reached at

[1] TCM 2017-34.

[2] Reg. Section 1.469-5T(a).