Tax Court Denies Real Estate Professional Status for Carriage House Investor

Last week, the Tax Court ruled in Foradis v. Commissioner, T.C. Summ. Op. 2024-13, that a real estate investor could not claim a tax loss from rental real estate of $22,376.

The taxpayer built a carriage house in their backyard with the intention of renting it on a short-term basis.

This is a case where a taxpayer attempted to qualify as a real estate professional but was woefully underprepared and uninformed as to the nuances of real estate professional status.

Let’s break it down.

The 2020 Tax Return

On the 2020 return, the taxpayer reported gross rental income of $875, interest expense of $6,729, and depreciation expense of $16,522.

It’s important to point out the first major red flag is the lack of completeness related to the carriage house reporting.

• Where is the allocation of property taxes and insurance?
• What about maintenance, repairs, loan cost amortization?
• Management company costs?

This was clearly a taxpayer who DIYd their return or hired a cheap tax pro to get the job done. But when it comes to rental real estate, taking the cheap route will prove to be more costly in the long run.

The Carriage House and Real Estate Professional Status

Interestingly, the Tax Court refers to the carriage house as a short-term rental:

After petitioners built the carriage house, Mr. Foradis hired a rental management company on October 1, 2020, to manage the carriage house rental, including cleaning, vetting prospective tenants, and providing security. Petitioners rented out the carriage house as a short-term rental property beginning in October 2020.

Yet, no argument was made related to the short-term rental loophole which we have discussed ad nauseam.

This is likely because the taxpayer either (1) didn’t know about the short-term rental loophole; or (2) did not meet the 7-day test to exclude the short term rental from the definition of a rental activity.

Either way, the taxpayer attempted to argue they were a real estate professional on the basis they spent 2,500 hours building the carriage house.

To qualify as a real estate professional, one must work 750 hours in a real property trade or business and spend more time in real property trades or businesses than they do anywhere else.

The Tax Court took issue with the latter test because the taxpayer also had a full time W2 job where they spent 2,000 working during 2020:

The Court finds it implausible that Mr. Foradis, as he asserts, would work 40 hours each week at a full-time job and at the same time work about an additional 48 hours each week constructing the carriage house.

This is consistent with historic rulings on real estate professional status. Many taxpayers have tried to prove to the Tax Court that they spent more time on real estate than their full-time job.

All have failed.

The Tax Court’s Opinion

The Tax Court ruled against the taxpayer and left the taxpayer owing roughly $5,000 in back taxes:

Assuming, without finding, that Mr. Foradis also performed personal services with respect to petitioners’ rental real estate activity, petitioners cannot prove that Mr. Foradis spent more than one-half of his total personal services performed in trades and businesses on his rental real estate activity during 2020. See I.R.C. § 469(c)(7)(B). Thus, because Mr. Foradis failed the first of the section 469(c)(7)(B) tests, petitioners are not entitled to deduct the loss from their rental real estate activity in 2020. Therefore, the Court need not address the reasonableness of the receipts or logs and whether Mr. Foradis performed more than 750 hours of services during the taxable year in real property trades or businesses in which he materially participated.

Real estate professional status is a highly nuanced area of the tax code.

If you claim real estate professional status, you should not do so without professional help.

Our team works with clients who are claiming, or would like to claim, real estate professional status. We also have successful audit defense experience related to real estate professional status and the short-term rental loophole.