Real Estate Professional Status: A Tax-Saving Strategy for Investors and Professionals
By: Nestor Caballero, CPA
Are you a real estate investor or professional looking to reduce your tax obligations? Qualifying as a real estate professional for tax purposes can provide significant tax benefits. In this post, we will cover what it means to qualify as a real estate professional and how it can impact your tax liability.
What is Real Estate Professional Status?
Real estate professional status (REPS) is a designation by the IRS that allows real estate investors and professionals to deduct losses from real estate activities against ordinary income. To qualify as a real estate professional, you must meet two criteria:
More than half of the personal services performed in all trades or businesses during the tax year were performed in real property trades or businesses in which the taxpayer materially participated.
The taxpayer performed more than 750 hours of services during the tax year in real property trades or businesses in which he or she materially participated.
Benefits of Real Estate Professional Status
Qualifying as a real estate professional can provide several benefits, including:
Deducting losses from real estate activities against ordinary income.
Income or gains from real estate activities are not subject to the net investment income tax.
Reducing taxable income by writing off significant losses, including depreciation from real estate activities.
Using rental losses to offset non-passive income.
Reducing state and local tax obligations.
Potentially creating tax-free cash flow during the ownership period.
How to Qualify as a Real Estate Professional
To qualify as a real estate professional, you must meet the two criteria mentioned above.
It is important to keep detailed records of activities and time spent working on the properties to verify real estate professional status in case of an IRS audit.
The IRS says that you can prove your real estate professional status through any "reasonable means," which the IRS does not actually specify. However, contemporaneous daily time reports, logs, or similar documents are not required if the extent of such participation may be established by other reasonable means.
Consider tracking your real estate activities by using a separate email account for all real estate activities, which will make it easier to find and track emails if needed for an audit. Other reasonable means to establish real estate professional status include calendars, appointment books, or other documentation that shows the time and dates of the services performed.
It is important to note that the IRS requires detailed records to support the hours worked in real estate compared to those worked in other businesses.
Qualifying as a real estate professional for tax purposes can provide significant tax benefits for real estate investors and professionals. However, it is important to meet the requirements and keep detailed records to verify real estate professional status in case of an IRS audit. If you are a physician or business owner, obtaining real estate professional status can be an invaluable strategy that can provide you with tax benefits now and in the future. With this designation, you can offset a portion of the income from your practice with various deductions associated with managing rental properties, reducing your state and local tax obligations.