Unleash the Power of the Real Estate Professional Status (REPs)

Real Estate Professional Tax Benefits

By definition, the IRS designates any rental activity as “passive”, regardless of how much time you invest in that activity. The IRS also loves to make exceptions, which is where the ‘real estate professional’ designation comes into play.

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A real estate professional that materially participates in rental real estate activities is not subject to the rule that treats all rental activities as passive, and may enjoy ordinary losses from their qualifying rental activities, without limitation.

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You are a Real Estate Professional if…

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1. You own rental real estate.
2. You perform more than 750 hours of personal services in a real property business that you materially participate in.
3. At least half (50%) of all your personal services are performed in a real property business that you materially participate in.

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☝️ Time spent on education and research are not considered personal service hours

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What’s Next?

If you meet the three tests to qualify as a real estate professional, congrats! You’ve conquered the first hurdle on the journey to enjoying some nice tax benefits.

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🔑 In order to overcome the passive loss limitations for rental real estate, you must:
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☑️ Qualify as a real estate professional and
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☑️ Materially participate in the specific rental real estate activity that’s generating a loss

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You have Material Participation if…

At a high level, material participation is achieved if you participate in an activity on a regular, continuous, and substantial basis during the year. To demonstrate this, you must meet at least one of the following seven tests:

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1. You participated in the activity for more than 500 hours during the tax year.
2. Your participation was substantially all of the participation in the activity of all individuals for the tax year.
3. You participated in the activity for more than 100 hours during the tax year and participated in the activity at least as much as any other individual for the tax year.
4. The activity is a significant participation activity and your participation in all significant participation activities exceeds 500 hours.
5. You materially participated in the activity for any five of the preceding ten tax years.
6. The activity is a personal service activity and you materially participated for any three (whether or not consecutive) preceding tax years.
7. You participated in the activity for more than 100 hours during the tax year and you satisfy a facts and circumstances test proving that the you participated on a “regular, continuous, and substantial” basis. Your participation in managing the activity does not count in determining whether you materially participated under this test if
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   1. Any person other than yourself received compensation for managing the activity, or
   2. Any individual spent more hours during the tax year managing the activity than you did (regardless of whether they were compensated for the management services).

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Special Circumstances

Depending on your personal situation, there may be some additional factors to keep in mind when evaluating material participation

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• Married Individuals: Any participation in activity by you or your spouse will qualify as participation for these tests, regardless of filing status and/or ownership interest in the activity.
• Employees and minority owners: You must directly or indirectly own at least 5% stake in an activity in order for your time to qualify as participation for these tests.
• Limited Partners (LPs): Material participation is only available to LPs meeting tests #1, #5 or #6. Keep this in mind if you plan to group LP interest in real estate syndicates to claim losses.

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1.469-9 Election to group rental real estate activities

‍Each rental real estate activity is treated separately, unless you elect to treat all rental real estate activities as a single activity.

This election is usually advantageous, but will impact when suspended losses of the aggregate rental activity are triggered.

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Participation Guidelines

Any "participation" is counted unless it’s primarily performed to avoid the passive loss rules.

Proof of Participation

Your participation in an activity may be established by any reasonable means.

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Reasonable means usually involves identifying services performed and the approximate number of hours spent performing those services over a period of time. This can involve:

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• Calendars
• Work product and notes
• Appointment confirmations, or
• Narrative summaries

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Contemporaneous daily time reports, logs, or similar documents are not required if the extent of your participation may be established by other reasonable means.

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☝️ Although the regulations permit some flexibility, they do not allow a post event "ballpark guesstimate" of time committed to participation in a rental activity or your own unverified, undocumented testimony.

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Investor Participation Limitations: Investors cannot "participate" unless they are directly involved in the day-to-day management or operations of the investments. Work performed as an investor includes:

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1. Studying and reviewing financial statements or reports on operations of the activity
2. Preparing or compiling summaries or analyses of the finances or operations of the activity for the taxpayer's own personal use
3. Monitoring the finances or operations of the activity in a non-managerial capacity.

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Red Flags

IRS agents are trained to pay particular attention to the following when analyzing returns with losses deducted under the real estate professional exception:

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🚩 Wages and compensation for services unrelated to real property.

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Solution: Maintain records establishing you meet the 50% of personal services test. It will be extremely challenging to meet this criteria with a full-time, non-real estate job.

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🚩 Spouses who both claim real estate professional qualification

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Solution: Each spouse meets 750 hours and 50% of personal services tests individually, and time spent has not been combined. Note: spouses’ time may be combined for determining material participation, not for real estate professional qualification

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🚩 Material Participation in more than one real estate activity

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Solution: Maintain records establishing you meet the material participation test for your rental activity, either directly or via a 1.469-9 Election.

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🚩 Your qualifying real estate activity has management fees

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Solution: Maintain records establishing you meet the material participation test for your rental activity, either directly or via a 1.469-9 Election

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🚩 Claims that you are engaged in a real property trade or business

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Solution: Ensure your services used to qualify for the real estate professional tests are directly related to a real property trade or business.

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Example: A lawyer specializing in real estate is providing legal services to the real estate industry, not real property services.

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Key Definitions

Rental real estate is any real property used or held for use by customers in a rental activity.

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A Real Property Trade or Business is a trade or business engaged in any of the following real property activities:

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• development, redevelopment
• construction, reconstruction
• acquisition, conversion
• rental, leasing
• operation, management or
• brokerage