Dump Your Limited Partnership Today

Yup, that makes sense. So, is it still true then that LLCs are the best entity for Real Estate Investors? (I know, I know, this is one of those too-generic questions that will get an “it depends” answer… but you know what I mean…)

After reading the various posts regarding the IRS and how they are handling real estate losses I realize I am not alone, especially here in California. But I am now even more confused (and nervous) then I was before I started reading. My scenario is this- I am (and have been since 2002) a mortgage broker who owns a 50% interest in my current company since 2004. In 2004 I bought (4) 4 unit building in Phoenix with a partner (my next door neighbor) in Arizona. I’ll save the long story for a book but the nuts and bolts of it were we should have done more due diligence on the area because these things turned out to be a NIGHTMARE. We managed the properties ourselves and made at least one trip monthly to collect rents and do small repairs to the properties as well as numerous trips to Phoenix from San Diego via car and air with tools to perform more extensive repairs over multiple days. Aside from dealing with crackheads, drug activity, murders in the back alley, someone shooting the on site manager, phone calls to police, immigration (there was a coyote smuggling ring in one of the units) County and City DA’s and code enforcement officials ourselves the IRS is now questioning my material participation.

This all came to light in the 2006 tax year when my tax preparer said I wouldn’t be able to claim the almost $80,000 loss I took by trying to get these places ready to sell (the city of Phoenix recoded a document prohibiting us from renting the units until a 25 page code violation order was rectified) and FINALLY disposing of them. I asked him why and he said that rental losses were passive. I was floored and then called the accountant who did the books for the LLC (which is a 50/50 ownership split) in which we held the properties. I got them on a conference call and my tax prepaprer said “OHH…I’m sorry I din’t understand that so I’ll file an ammened 2005 return with active participation and fix the 2006 return.”

After I filed the ammended return for 2005 in May of 2007 (that now showed me getting an $8000 refund) I started to follow up in November of 2007 after no response. Finally in April of 2008 I got a phone call and letter that I was going to be audited for the material participation. After the auditor reviewed my emails, plane tickets, etc.. and we had a 4 hour examination in which I gave her the long version of what happend she said she would get back to me but it looked like everything was in order. She took more than 2 months (after saying next week I will get to it, next week I will get to it, on and on…..) She informed me that they were disallowing the claim as I didn’t materially participate!!

To be compltely honest I can’t even FATHOM that I would not be considered to have materially participated (which I told her). In addition wouldn’t being a real estate professional put the scale more on my side? In addition there were only 2 members in the LLC. How does the IRS think that the properties were managed?! I am completlely flabergasted that there is even a question of my material participation. Does anyone have any suggestion as to what I would need to provide the IRS to prove my case? I guess I can get all my phone records, emails, plane tkcets, car rental reciepts, hotel receipts, etc and recreate a daily log of my time allocation that would far and away exceed the 750 hours rule but that would require another 750 hours of work to put together most likely. Or do I need to go spend $250 per hour on a tax attorney to defend the TRUTH??!!?!? Any help would be appreciated

Thanks for the reply….The auditor did say that I would be able to take all the losses for 2006 but I don’t think that would help me get that $8000 from 2005? I think I got a total refund of tax paid in 2006 as it was. I did speak to the auditor and she said she would be setting up a meeting with her manager and I on Wednesday (July 2, 2008). Is that the office level appeal you are referring to? I would love to get my hands on that info before then, is that possible?

I think the IRS is just denying ANYTHING right now and as time erodes memory the auditor took with her just ONE of the 100’s of emails I presented her with and a quickie little 1 page thing I put together while she was here alotting my time. I think she actually reviewed those two items to determine the material participation!!

In addition I am quite sure the preparer did not file the election. Is this something that could be ammended as well?

I have filed for 2007 already…Who is Richard? I am in desperate need of a new tax person!!

What should investors who get K-1’s be thinking about? Is this a problem that’s going to roll downhill our way?

Thanks for the advance warning.