Real estate ownership has many tax benefits, with additional advantages for those who meet the criteria for being a real estate professional. Becoming a real estate professional (REP) may require extra effort, but the reward is lower taxable income through deductions for real estate losses, including depreciation. Therefore, it’s important for real estate owners to understand the requirements and ensure they qualify for this status. This may involve seeking professional advice or guidance from a tax expert.
To take advantage of the tax benefits of being a real estate professional, individuals must meet the criteria set forth by the Internal Revenue Service (IRS). According to IRS Publication 925, two requirements must be satisfied to qualify.
1. To meet the requirement, an individual must have performed more than half of their personal services in real estate trades or businesses in which they materially participated during the tax year.
2. To be considered materially participating in real property trades or businesses, an individual must have performed more than 750 hours of services in such trades or businesses during the tax year.
It’s important to note that the IRS does not consider an individual’s real estate license as a factor in determining real estate professional status. Instead, the focus is on how the individual spends their time and the amount of time they devote to real estate activities.
Additionally, if an individual is filing their taxes jointly with a spouse, only one of them needs to meet these requirements to use the benefit. This means that as long as one of the individuals satisfies the criteria for being a real estate professional, the couple can take advantage of the tax benefits associated with this status.
Typically, losses from rental real estate are considered passive activities and subject to limitations on deducting passive losses. However, if a taxpayer qualifies as a real estate professional and actively participates in their rental properties, they can avoid these limitations and deduct rental losses against other sources of income, such as commissions and wages, according to IRC Section 469(c)(7). Being qualified as a real estate professional provides substantial benefits, including the possibility of generating tax-free cash flow during the ownership period.
Achieving real estate professional status can be challenging for taxpayers who only have a few rental properties, particularly if they also have a full-time job that pays a W-2. Regardless, the IRS and courts emphasize the importance of maintaining detailed and credible records of time spent on real estate activities. Recent tax court decisions have favored the IRS, highlighting the need for accurate record-keeping. These records must accurately reflect the time spent performing real property services and not just rough estimates that may include time spent on travel and breaks.
When striving for real estate professional status, there are many factors to consider. If you are looking for an experienced real estate tax accountant or have a question, feel free to contact us at Accolade Accounting. You can call us at (470) 646-2663 or email us at office@accoladeaccounting.com.
Until next time my friends,
Cheers!
JD Longino, CPA
