04 Feb Information for Real Estate Professionals
Qualify as a Real Estate Professional to Deduct Rental Losses
You can be a lawyer or medical doctor and also qualify as a real estate professional with respect to your rental properties.
The classification as a real estate professional improves your after-tax rental property profits by allowing passive loss tax deductions that require your partner (the government) to chip in with tax money.
With good planning, you can get your IRS partner to chip in its cash sooner rather than later. Sooner builds your profits quicker and to a higher level (because you have more cash to invest earlier).
Real estate professionals who meet the material participation standards may deduct their rental property passive losses immediately, regardless of their incomes. Non-real estate professionals with joint incomes over $150,000 may not deduct their losses until later—perhaps, not until they sell the property.
Thus, to maximize your real estate profits, you may want to qualify—or, if married, want your spouse to qualify—as a real estate professional.
Qualifying as a Real Estate Professional
Either you or your spouse will qualify as a real estate professional for the year if you or your spouse spends1
More than half your personal service work time in real property trades or businesses in which you materially participate, and
More than 750 hours of your personal service work time and investment analysis time in real property trades or businesses in which you materially participate.
Example. You work 925 personal service hours a year on your rental properties and 921 hours (excluding vacations, holiday, and sick days) on your W-2 job as the owner-employee of your S corporation. You pass the 750-hour test and you pass the more-than-half-your-work-time test (1,846 total personal service hours divided by 2 equals 923 hours—you worked 925 hours on the real estate). Thus, you are a real estate professional for the year, and you may deduct your rental property losses on the properties in which you materially participate.
Planning note. Investor time counts for the 750-hours test but not for the more-than-half-your-personal-services-work-time test.2
One spouse must single-handedly satisfy the time-spent rules for real estate professional classification. When one spouse passes the time tests, both spouses are deemed to pass. Thus, if the wife qualifies by herself as a real estate professional, tax law deems the husband a qualified real estate professional, too.3
Proof of Time Spent
You need proof of time spent. In its audit guide on rental properties, the IRS lists the following two techniques for IRS examiners to follow:4
Request and closely examine the taxpayer’s documentation regarding time. The taxpayer is required under Reg. Section 1.469-5T(f)(4) to provide proof of services performed and the hours attributable to those services.
Scrutinize other activities the taxpayer is engaged in, to determine whether time claimed makes sense.
The IRS tells its examiners that your “reasonable records” of time may include5
• Identification of the services provided; and
• The approximate number of hours spent, based on appointment books, calendars, or narrative summaries.
Keep in mind that the burden of proof is on you. Thus, you need proof of time spent.
Real Property Trades or Businesses
Time spent on your rental property is time spent on your real property trade or business. Remember, either you or your spouse must pass the time test for real property trades or businesses in order to qualify for tax-favored real estate professional status.
The term “real property trade or business” means any real property6
• leasing, or
• brokerage trade or business.
Employee alert. Personal services performed as an employee do not count as work performed in real property trades or businesses unless such employee is a 5-percent-or-more owner.7 You are a 5-percent-or-more owner if you own (or are considered to own) more than 5 percent of your employer’s outstanding stock, outstanding voting stock, or capital or profits interest.
Real estate agent. Brokerage includes activities by a real estate agent.
Your legal share of government subsidies for your rental properties depends on either your:
• income being low enough so that you can deduct losses up to $25,000, or
• qualifying as a real estate professional who materially participates in the rental activity.
1 IRC Section 469(C)(7)(B).
2 Reg. Section 1.469-9(b)(4).
3 IRC Section 469(c)(7)(B)(II).
4 IRS Passive Activity Loss Audit Technique Guide (ATG), Training 3149-115 (02-2005), pp. 2-5, 2-6.
5 Ibid., p. 4-7.
6 IRC Section 469(c)(7)(C).
7 IRC Section 469(c)(7)(D)(II).