Court: What counts is material participation

A federal district court in California has applied the passive activity loss rules to deny a deduction to a real estate professional for losses from rental real estate activities.

Charles Gragg is a corporate executive. Delores Gragg is a real estate agent. The Graggs also own two rental real estate properties that have produced losses, which the Graggs deducted on their federal income tax returns. The IRS disallowed the rental losses under the passive activity loss rules.

The court agreed with the Graggs that Dolores was a real estate professional, based on her activities as a real estate agent. However, the court agreed with the IRS that the Graggs’ rental real estate activities were passive activities (Charles and Delores Gragg v. United States, 113 AFTR 2d 2014-XXXX, March 31, 2014).

The court said that the real estate professional exception to the passive activity loss rules means only that a rental real estate activity is not automatically passive. The Graggs still had to show that they met the material participation standard with respect to the rental real estate activities – a standard the court said they failed to demonstrate.