IRS Considers Limitation on Passive Activity Losses and Credits

Third Party Communication: None

Y is a state licensed mortgage broker. As a mortgage broker, Y markets mortgage loans and brings together lenders and borrowers. Under state law, Y's mortgage brokerage business is considered to be a real property brokerage business.

It has long been held that Federal law governs the construction of terms for Federal tax purposes. See Julius M. Israel Lodge of B'nai B'rith No. 2113 v. Comm'r, 98 F.3d 190 (5th Cir. 1996) (citing United States v. Irvine, 511 U.S. 242 (1994)); Hoover v. C.I.R., 102 F.3d 842, 845 (6th Cir. 1996) (stating "federal law governs the federal income tax treatment of [ § 71 ] property."). Thus, state law definitions of the terms "real estate agent" and "mortgage broker" are not determinative of whether a taxpayer is engaged in a real property brokerage trade or business within the meaning of § 469(c)(7)(C).

Although Congress initially included "finance operations" in the list of qualifying real property trade or business activities in an earlier, unenacted version of what would become § 469(c)(7)(C), (H.R. 3732, 101st Cong. (2d Sess. 1989), S. 2384, 101st Cong. (1989-90)), "finance operations" was removed from the final bill. H.R. 2264, 103d Cong. (1993) (enacted). It is therefore reasonable to infer that Congress did not intend for financing activities to constitute a real property trade or business and that financing activities should not be included in the definition of "real property brokerage."

Moreover, principles of statutory construction indicate that a mortgage broker is not engaged in real property brokerage. "Statutory words are uniformly presumed, unless the contrary appears, to be used in their ordinary and usual sense, and with the meaning commonly attributed to them." Caminetti v. United States, 242 U.S. 470, 485-86 (1917); Smith v. United States, 508 U.S. 223, 228-29 (1993). Courts often resort to standard reference dictionaries to determine the ordinary or common meaning of a word. See, e.g. Smith, 508 U.S. at 228; Crane v. Comm'r, 331 U.S. 1, 6 (1947).

Webster's Dictionary defines "real estate" as "property consisting of buildings and land; the business of selling land and buildings," and defines "brokerage" as "the business of a broker" or the "broker's fee or commission."¹ Webster's defines a "broker" as "a person who helps other people . . . to buy and sell property."² Accordingly, the common and ordinary construction of "real property brokerage" for purposes of § 469(c)(7)(C) involves bringing together buyers and sellers of real property. This definition of "real property brokerage" does not include the brokerage of financial instruments.

Therefore the "financing" of real property such as by bringing together lenders and borrowers is not a real property brokerage trade or business within the meaning of § 469(c)(7)(C). Thus, consistent with the legislative history of § 469(c)(7)(C), and under the common and ordinary construction of "real property brokerage," X is engaged in a real property trade or business within the meaning of § 469(c)(7)(C), and Y is not.

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²Merriam-Webster Online Dictionary, "Broker" (Apr. 30, 2014), http://www.meriam-webster.com/dictionary/broker.