When taxpayers attempt to reconstruct their hours in activities from memory when they receive an exam notice to sustain their burden of proving qualification as a real estate professional, the result is rarely a successful defense of that assertion. Many of the problems are illustrated in the case of Pourmirzaie v. Commissioner, TC Memo 2018-26.

The taxpayers did have several rental properties. The Court listed them as follows:

A four-unit residential property in San Jose, California (San Jose property);
A single-family condominium in San Diego, California, in which petitioners owned a partial interest (San Diego property);
A single-family residence in Tucson, Arizona (Tucson property);
A single-family condominium in Bremerton, Washington (Bremerton property); and
A single-family residence in Discovery Bay, California (Discovery Bay property).

The taxpayers did not maintain any sort of log or calendar of the work performed on these properties during the years in question. Nevertheless, on their tax returns for the year in question they took the position that Mrs. Pourmirzaie was a real estate professional.

To be a real estate professional, she needed to show that she both spent more than ½ of the time she spent in businesses in which she actively participated in real estate businesses and that her hours in the real estates business were more than 750 hours. Even though the couple was filing a joint return, a spouse is not allowed to use time performed in the activity by the other spouse to establish real estate professional status.[1]

Since the taxpayers had kept no records at the time, they scrambled to prepare documents to detail their activities from their memories once the examination began. The prepared calendars for two years, and Mrs. Pourmirzaie testified at trial about additional time she believed she spent on the various rentals.

Ultimately, they came up with the following details of hours worked that they proposed showed that the taxpayer was a real estate professional:

Petitioners propose that, on the basis of daily entries on the 2010 and 2011 calendars, we find that Mrs. Pourmirzaie spent 790 hours and 949 hours during those years, respectively, at the San Jose property doing, generally, routine cleaning, repairs, gardening, bill paying, and surveillance. They propose that, on the basis of her testimony, we find that she spent 15 to 20 hours a week at the San Jose property carrying out those tasks. They propose that, on the basis of entries in the 2010 and 2011 calendars, we find that Mrs. Pourmirzaie spent 275 hours and 178 hours during those years, respectively, at the San Diego property doing, generally, “remodeling, repairing, and interviewing tenants to rent out the property.” On the basis of Mrs. Pourmirzaie’s testimony, petitioners propose that we find that she “spent one or two hours per month or year” managing the Tucson property. Petitioners propose no finding with respect to the number of hours that Mrs. Pourmirzaie spent during any of the audit years managing either the Bremerton or the Discovery Bay property. They propose that we find that, in 2010, Mrs. Pourmirzaie spent approximately 1,064 hours on her rental activities and that, in 2011, she spent approximately 1,127 hours on her rental activities.

As is often the case, when the taxpayers attempt to reconstruct a calendar from memory, the reconstruction collapses upon closer inspection. The Court noted several issues with the calendars:

The 2010 calendar has entries for every Saturday and Sunday in 2010 other than Sunday, October 31 (Halloween), and Saturday, December 25 (Christmas Day). The usual, uniform entry for both Saturday and Sunday is, without identifying a location (but we assume the San Jose property), “Weekly Cleaning and Repairing”, from 10 a.m. to 6 p.m. on Saturday and from 10 a.m. to 4 p.m. on Sunday. There are occasional entries for time spent in San Diego. There are twice a month entries for midweek “Security Surveillance”, uniformly from 8 to 10 p.m., and there are assorted other entries on various dates, such as “Home Depot”, “Paperwork and Bill Paying”, and “Post Office”, some lacking time entries and some, like “Paperwork and Bill Paying”, showing twice monthly time entries, usually from 7 to 8 p.m. The 2010 calendar does not specify who, as between Mr. or Mrs. Pourmirzaie, performed the listed tasks.

The 2011 calendar is similar although it does show monthly totals of hours for each petitioner, totaling, for the whole year, 1,133 hours and 905 hours for Mr. and Mrs. Pourmirzaie, respectively. The 2011 calendar shows 2 hours of surveillance from 8 to 10 p.m. on April 27 and 3 hours on paperwork and bill paying from 7 to 10 p.m. on April 29. Monthly statements for petitioners’ checking account at Wells Fargo Bank for the months of April and May 2011 show check card purchases for food and lodging on April 28 and 29 in London, England, and at Heathrow airport. There are no domestic purchases shown for either of those dates. The 2011 calendar shows both petitioners working at an unspecified property from 10 a.m. until 4 p.m. on August 7. The Wells Fargo Bank statement for August 2011 shows food purchases in Dallas, Texas, on that date. The 2011 calendar shows one or both petitioners working at unspecified properties for 40 hours on September 9 through 13. The Wells Fargo Bank statement for September 2011 shows food and other purchases and a cash withdrawal in Philadelphia, Pennsylvania, on those dates. The 2011 calendar shows Mrs. Pourmirzaie working at an unspecified property on October 22 and 23. The Wells Fargo Bank statement for October shows food and other purchases in New York, New York, Boca Raton, Florida, and Philadelphia, Pennsylvania, on those dates.

Beyond those problems, the Court found other issues with the calendars, noting:

We have little confidence that the 2010 and 2011 calendars accurately reflect the dates and the times that petitioners, and, in particular, Mrs. Pourmirzaie, spent at either the San Jose or the San Diego property. The calendars were prepared from memory, after the audit years, during the course of respondent's examination of the audit-year returns, without benefit of any contemporaneous time records. The calendars show an exactitude as to the dates and the times petitioners were at the San Jose and San Diego properties not matched by Mrs. Pourmirzaie's memory at trial, where she testified that, for any 2010 visit to the San Jose property, she could not recollect the time they went or returned and the length of their visit depended on the amount of work to be done. With respect to the San Diego property, she testified that she could not recall how many times she visited the property in 2010 or the types of management activities that she performed. On her visits to San Diego, she added, she stayed longer than was necessary because “I love San Diego.”

Nor did the court accept the assertions made about time spent other that in the calendar. Specifically, the Court found:

Mrs. Pourmirzaie testified that she and her husband shared responsibility for management of both properties. She was clear that, on weekends, they both visited the San Jose property for a total of 14 hours each. Her husband, she testified, was a workaholic. Nevertheless, she proposes that we find that she, herself, spent 15 to 20 hours a week at the San Jose property carrying out management tasks. If we add to her suggested totals the 14 hours a week that her husband was at the San Jose property performing management tasks, then we have the couple spending 29 to 34 hours a week managing a four-unit residential apartment building at which they neither kept an office nor stored any tools. Simply stated, we do not believe it.

The Court did not find that the taxpayers had shown that Mrs. Pourmirzaie spent more than 750 hours in real estate activities in the years in question and, therefore, she was not a real estate professional.

Advisers should take note of this case, because the position of the taxpayers in this case (“we work on the real estate a lot of hours and I’m sure it’s more than 750 hours for one of us”) is one that advisers will hear often. But when asked if the taxpayers have documentation of the hours they will admit that they don’t have it—but, really, they spend a lot of time on these projects. Often if the adviser points out the problem, the taxpayer will then suggest that they are willing to “take the chance” and claim the deduction.

In this case, the taxpayers were hit with the 20% substantial understatement penalty because the Court found, properly, that there existed no substantial authority for this position. As well, the taxpayers did not offer up evidence that they had reasonable cause and acted in good faith. However, if they had made use of a tax professional (there’s no evidence that they did in this case), one way to show reasonable cause and good faith is to claim reasonable reliance on the advice of a competent professional—they would argue the professional had assured them that the position was justified and they signed the return containing that position based on that reliance.

In such a case, an adviser may end up in an extremely difficult position. To sustain that defense, the taxpayer normally will need to either show written advice that counseled them the position was acceptable or have the adviser testify that he/she was asked to advise on the matter and told the taxpayer this was fine. Since the written document generally won’t exist (remember, the taxpayer was willing to “take the risk” on the position), the adviser’s testimony will be needed.

Of course, the adviser is going to say that he/she did not give that advice. But at that point the client’s memory is likely to get hazy (“we never said take the risk, we just wouldn’t do that”) and regardless of a client’s willingness to take on the risk, an adviser would not be able to sign a return taking a position without substantial authority unless the position had a reasonable basis and that position was disclosed on the return. Doing so would be in violation of the AICPA Statements on Standards for Tax Services No. 1 and IRC §6694, subjecting the preparer to possible discipline and preparer penalties.

[1] IRC §469(c)(7)