Are you a “real estate professional”? If so, you may get some tax breaks.
Real estate ownership is known to provide several tax benefits, but many taxpayers are unaware of additional perks available to those who qualify as “real estate professionals”. This tax-specific designation lets qualifying investors deduct additional business expenses, losses, and property depreciation from their overall taxable income.
Typically, income and losses arising from any rental activity are considered passive, and the IRS allows taxpayers to deduct up to $25,000 annually in passive real estate losses against their earned income, as long as have at least a 10% ownership interest in the property, actively managed the real estate, and earned less than $100,000 during the year.
While the rental real estate loss allowance is beneficial, the limits and phaseouts leave many real estate owners unable to fully maximize the deductions.
However, taxpayers that qualify as “real estate professionals” are not subject to the $25,000 limitation or to income phaseouts, thereby allowing them to claim rental losses against other types of income (including wages, interest and dividends, and business income.)
What is a “real estate professional”?
The “real estate professional” (“REP”) determination is made each year. For this purpose, an individual qualifies as a REP in the eyes of the IRS if:
- More than 50% of the personal services performed by the taxpayer in all trades or businesses during the tax year are performed in real property trades or businesses in which s/he materially participates, and
- The taxpayer performs more than 750 hours of service during the tax year in real property trades or businesses in which s/he materially participates.
What is a real property trade or business?
The relevant tax code defines “real property trade or business” broadly, to include the following specified activities:
- Development or redevelopment
This means that hours spent performing activities like bookkeeping, making repairs, executing contracts, screening tenants, advertising, paying taxes and utilities, procuring insurance, and dealing with homeowners’ associations all may count towards the material participation threshold.
How could this look on a tax bill?
For example, let’s say you had $35,000 in losses (perhaps due to property vacancies and improvements) and an additional $15,000 in depreciation across your rental portfolio, and your total income from the year was $200,000. If you were classified as a REP, the combined $50,000 could be deducted from that $200,000. This would lower your overall taxable income to $150,000 for the tax year.
Do both spouses have to qualify as a “real estate professional”?
No. for a husband and wife, only one of the spouses must individually satisfy the 50% services test and 750-hour test.
- Taxpayers have the burden of substantiating their participation in real property trades and businesses and should prepare and save documents to substantiate the time spent on and the services performed for the activities for each tax year.
- Hours spent managing short-term rental property (averaging less than seven days rental), such as a hotel or bed & breakfast, may not count toward the 750-hour test.
- You may need to elect to treat all rental real estate activities as a single activity in order to meet the material participation tests.
- The non-passive treatment applies to net rental income, too. For REPs who have net passive losses from other sources, such as a limited partnership interest, they would not be able to deduct those losses against net rental income in the current year, but could suspend those losses and carry them over to the next year.
- Personal services performed as an employee are not treated as performed in a real estate trade or business unless the employee has more than 5% ownership (direct or indirect) in the employer.
- Income received as a REP may be subject to self-employment tax (that otherwise would not).
As with most things tax-related, the devil is in the details and real estate property owners should consult a professional tax advisor for guidance maximizing your deductions according to your own personal financial situation.
For more information about tax-advantaged securitized real estate investments that can allow you to retire from being a landlord, please call 1031 Capital Solutions at 1-800-445-5908 or visit our website, 1031capitalsolutions.com.
This is for informational purposes only, does not constitute as investment advice, and is not legal or tax advice. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. Please consult the appropriate professional regarding your individual circumstance.
Numerical examples are for illustration purposes only. Individual results may vary.
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Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC (CAM), an SEC-registered investment adviser. 1031 Capital Solutions is independent of CIS and CAM.