Schedule E

Tax Research Memo Facts: The situation involving John's deduction under Schedule E. is somewhat questionable. This is because he can show that he has a loss from the property. However, it is unclear what his deductions are or if there are any other properties where he was able to generate passive income. At the same time, he used a real estate management firm to rent the property to possible tenants. He paid them a commission of 35% on all income received.

In the last year, they rented the cabin for a total of 9 nights and 12 days. John also spent time at the location accounting for 19 nights and 27 days. On his taxes, John took a $20,000.00 deduction under Schedule E. (Murphy, 2013) The biggest issue is determining if John was entitled to this deduction. It is obvious that he did not actively manage the selection of the tenants or work out the terms of the legal contract.

Moreover, it is unclear about the possible income he received, potential damages that had to be repaired and any kind of deposits accepted in advance. To make matter worse, there is the probability that the management company handled every aspect of the maintenance, rentals and administration. This means that his write offs for losses on his taxes are questionable.

(Murphy, 2013) A good example of this can be seen with observations from Brotman (2013) who said, "Rental property has been a particular subject for abuse in recent years with the dramatic changes in the housing market. As such, many people have been unscrupulously padding losses into their investment properties to help offset income from other sources. This happens frequently with those who have portfolios with multiple properties and who may be unfairly using losses to offset large gains.

In some cases, these losses can be fairly substantial and result in a significant tax loss to the government. Also, abnormal losses for a certain year may also raise a red flag particularly with frequently abused/misreported expense categories such as repairs and maintenance (the IRS will audit you for capital expenditure treatment)." (Brotman, 2013) This is illustrating how these issues could trigger some kind of audit from there IRS.

In John's case, these issues could be compounded based upon the fact that he could have taken these kinds of deductions over the last several years. If this is the case, these practices will be brought into question and increase the possibility of having his property scrutinized. (Murphy, 2013) Conclusion: This is problematic, as it could expose John to a possible audit from taking deductions which may or may not be allowable under the IRS Code.

The main issues are how much income was received, if he was involved in the management of the property, any other locations where he has received income from and the total amounts that were received in the process. (Murphy, 2013) Law and Analysis: Under Schedule E. Of the IRS Code, it clearly states that the use of these deductions requires maintaining some form of passive income. This means that John has to remain involved in the process of selecting, renting and addressing issues such as maintenance.

When a management firm is involved, they will handle all everything associated with the location and will send John a monthly check (after their commissions are deducted). The fact that he is using a management company is indicating that there is form of active management by involving real estate professionals in the process. (Murphy, 2013) Evidence of this can be seen with the IRS Code stating, "You are a real estate professional for any rental real estate activity in which you materially participated. This is not a passive activity.

Anyone who meets the one or both of the below criteria are considered to be professionals. 1) More than half of the personal services you performed in trades or businesses during the year were performed in real property trades or businesses in which you materially participated. 2) You performed more than 750 hours of services during the year in real property trades or businesses in which you materially participated. A real property trade or business is any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation and management.

If you qualify as a real estate professional, rental real estate activities in which you materially participated are not passive activities." ("2013 Instructions for Schedule E," 2013) This is problematic, as it is showing how John's deductions are not considered to be passive income. These opinions are based upon the fact that he hired professionals to actively manage the property and did not engage in various activities (such as: selecting renters, maintenance or any other issues). Instead, he simply received the income from the property. If this occurred over.