Professional Service Firms Articles
Attorney Who Leased Equipment to His Law Firm Was Actively Engaged in Profit-Seeking Activity

Target Audience: Legal Professionals, Professional Service Firms, Partners, Business Owners, C Corporation Law Firms

An attorney who leased equipment to his wholly owned C corporation law firm could deduct losses generated by the lease activity because (1) he engaged in the leasing business for profit, rather than as a hobby, and (2) the leasing activity was not subject to the passive activity loss limitation rules because it was incidental to a nonrental activity.

The attorney owned and operated a class-action law practice organized as a C corporation. He individually owned office equipment and state-of-the-art audio-visual equipment which he leased to the C corporation for use in his practice. This arrangement had the effect of converting what had been wage income subject to uncapped Medicare tax into rental income. In the two tax years at issue, the law firm had no income and was unable to pay rent, which generated a loss for the attorney on his leasing activities.

These losses were not hobby losses under Code Sec. 183 because the attorney engaged in the leasing activity on a for-profit basis. The revenues and expenses of the leasing activity could not be aggregated with those of the practice since the practice was organized as a C corporation and such comparisons would not work. Nevertheless, the attorney's leasing activity was clearly not a hobby masquerading as a business. The attorney followed his accountant's advice in setting up the arrangement, he used the equipment in his practice, he had a high degree of knowledge about the equipment, he used it as a marketing tool, he collected rent consistently except in the two years at issue, and he never used the equipment for personal use.

The passive activity loss limitation rules under Code Sec. 469 did not preclude the attorney from deducting the rental losses. Although rental activities are presumed to be passive activities, there is an exception for activities incidental to a non rental activity of the taxpayer. This exception is found in Temporary Reg. §1.469-1T(e)(3)(ii)(D) which requires the taxpayer to (1) own an interest in the trade or business to which the rental activity was incidental, (2) use the property in that business, and (3) not exceed certain limits in gross rental income. For these purposes, the taxpayer's activities include the activities of his wholly owned corporation, and it does not matter that the rental activity took place simultaneously with the use of the property by the business to which it was incidental. The attorney satisfied all three requirements since (1) he owned the C corporation, (2) he used the equipment in his practice, and (3) no rentals were generated in the years at issue.

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