Real Estate Professionals Must Materially Participate in Their Rental Activities in Order to Deduct Rental Losses

In the case of Gragg v. United States of America; Internal Revenue Service Commissioner, the Ninth Circuit Court of Appeals held that real estate professionals must materially participate in their rental activities in order to deduct rental losses.

The facts involved taxpayers, one of whom held a real estate license, who claimed losses related to rental properties they owned.  The IRS requested a log of the licensee's activities related to the properties and ultimately denied the deductions, concluding that, even though holding a real estate license, the taxpayers had to show that they materially participated in the rental property activity.  In this case, two undated one-page notes of activity submitted by the taxpayers were not sufficient for the IRS to allow the deduction.

In general "passive activity" losses are not deductible under IRC § 469.  However the taxpayers argued that the history of amendments to IRC § 469 meant that being a real estate professional rendered all rental losses non-passive and thus deductible.  The Ninth Circuit judges thought otherwise, and ruled that § 469's text and case law "all point in one direction" such that real estate professionals "must show material participation in rental activities before deducting rental losses."

The Bottom Line - Holding a real estate license does not automatically entitle you to deduct your rental losses.  If you wish to deduct your rental losses, be active in the management of your rental activities and document, document, document.


- Sunil Sethi


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