If you’re a real estate investor or considering investing in real estate, you have likely heard about the coveted real estate professional status for tax purposes. But what does that mean, and how can it benefit you?
Being a real estate professional isn’t just about owning property or being a landlord. It’s a specific tax status recognized by the IRS that, if you qualify, can dramatically change how your real estate income and losses are treated on your tax return. The biggest advantage being that you can use losses from your rental properties to offset other types of income. Most investors cannot do this due to passive activity loss rules.
To qualify as a real estate professional, you must meet two main IRS tests:
More than half of the personal services you perform in all trades or businesses during the year must be in real property trades or businesses. This includes activities like development, construction, acquisition, conversion, rental, operation, management, leasing or brokerage.
You must spend at least 750 hours during the year in real property trades or businesses in which you materially participate.
Even if you pass the two main tests, you must also materially participate in each rental activity for your losses to be considered non-passive. The IRS provides several ways to prove material participation, such as:
If you own multiple properties, you can elect to treat all your rental activities as a single activity for material participation purposes. However, this election is permanent and has long-term implications, so consider it carefully.
Most real estate losses are passive and can only offset passive income. But if you qualify as a real estate professional and materially participate, your losses become non-passive and can offset all types of income, including wages, business income and investment gains.
This status can unlock significant tax savings, especially for those with high incomes or substantial real estate portfolios. However, the rules are strict, and the IRS scrutinizes these claims closely.
Achieving real estate professional status isn’t easy, but for those actively involved in real estate, it can be a powerful tool for tax optimization. Because the requirements are nuanced and the stakes can be high, working with an experienced tax advisor or CPA — especially one familiar with real estate — is highly recommended.
Contact us here or call 800.899.4623 to learn whether you can qualify as a real estate professional and if this is the right tax strategy for you and your real estate.