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Tax Advantages for Real Estate Professionals

Tax Advantages for Real Estate Professionals

There are many real estate-related tax benefits; however, additional benefits are available to those who qualify as real estate professionals. While it may seem daunting to take the extra steps to achieve REPS (real estate professional status), eligible homeowners will enjoy the added benefits of reduced taxable income by reversing significant losses, including depreciation of real estate assets. Homeowners will want to familiarize themselves with the requirements and make sure they are eligible.

Who is a real estate professional, and why is it important?

Rental real estate losses on the leased property are generally considered liabilities and are subject to rules limiting the loss of liabilities. However, a taxpayer who is a real estate professional and participates significantly in their real estate rentals can avoid these passive loss limitations and can deduct real estate rental losses from other sources of income (commissions, salaries, etc.) according to IRC Section 469(c)(7). Eligibility creates significant benefits and the potential for tax-free cash flow during the period of ownership.

What are the requirements for becoming a real estate professional?

The most important aspect of qualifying as a real estate professional is how the professional spends their time. Anyone wishing to become a real estate professional must:

  • Own rental property

  • Devotes more than 50% of his/her time during the exercise to real estate or commercial activities in which the practitioner is materially involved and

  • Work more than 750 hours in the same real estate operation or business, devoting more than half of your service hours to your real estate business. Hours spent as an employee are not considered unless the employee owns more than 5% of the property.

Participants in real estate agreements or business include:

  1. Real estate developers, builders, and contractors.

  2. Owners of rented property,

  3. Real Estate, Leasing, and Purchasing Managers

  4. Real Estate Brokerage Participants - provided they meet the 50% and 750-hour participation requirements.

Note: Real estate appraisers and mortgage brokers are excluded

Material participation in real estate rental includes:

  1. Managing and operating the property rental business for more than 500 hours per year; or

  2. Perform all of the work necessary for the management and operation of the leased property during the year substantially, or

  3. Work more than 100 hours in the year without the participation of anyone other than the taxpayer.

  4. The individual materially performed a physical activity for any of the five tax years (even non-consecutive) during the 10 tax years immediately preceding the tax year.

Note: One spouse's business can be assigned to the other spouse, and the business with multiple properties can be combined using the appropriate options.

Note: Work done as an investor is not eligible (assessment of financial reporting and financial monitoring)

Avoid potential pitfalls

Most taxpayers with little rental property will have difficulty obtaining professional real estate status, especially if the taxpayer also receives a W-2 from full-time employment. Either way, the IRS and the courts have made it clear that detailed and reliable records of services must be kept. Recent rulings in favor of the IRS highlight the importance of keeping adequate records of the time spent conducting real estate business. Additionally, these time records should only accurately count time spent with real estate services, rather than "rough estimates," which may include time spent traveling and lunch breaks.

Aggregation of Rental Real Estate 

Each rental property is a separate business, so meeting the required 750 hours for each is nearly impossible unless the taxpayer chooses to combine them. A taxpayer may elect to combine all real property interests in real property, including real property held by pass-through entities, into a single asset. This may allow the taxpayer to pass the material participation tests when reviewed cumulatively. The choice to treat all the interests of the leased asset as a single asset applies for all subsequent years unless there is a significant change in the facts and circumstances. Taxpayers who do not formally elect to aggregate properties can make late elections by attaching a statement indicating that the taxpayer wishes to aggregate a property to their tax return. This can only be done if the corresponding tax returns have been filed as if the election had been made.

The five factors of asset grouping are similarities and differences in types of assets, degree of common control and ownership, geographic location, and interdependence between assets:

  • Buying or selling from each other

  • Having the same customers

  • The same employees

  • Having a single set of books and records



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