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The Basics of “Real Estate Professional” Status for Tax Purposes

J Scott
2 min read

One of the biggest challenges real estate investors face is keeping the profits that they earn from their investments. Just like any other business, the IRS is going to want to take as big a chunk of your profits as possible, and knowing how to use the system to your advantage will help you keep as much of your hard-earned investing cash as possible.

One of the best ways to limit the financial impact of taxes when it comes to real estate investing is to be able to claim “Real Estate Professional” status on your tax returns. If you can do this (and that’s a big IF), you have some hefty tax advantages you can leverage to keep more of your investment profit. That said, there is a lot of misinformation about what it means to be a “Real Estate Professional,” so hopefully I can cover the basics here.

First, let me take a minute to explain in more detail the advantages of claiming “Real Estate Professional” status on your tax returns:

If you invest in real estate part time (not a professional), you may be able to deduct a portion of your passive RE losses on your tax return. If your adjusted gross income (AGI) is less than $100,000, you can deduct up to $25,000 per year in passive RE losses against that income. This benefit phases out (incrementally drops from $25,000 to $0) if your AGI is between $100,000 and $150,000. And if your AGI is over $150,000, you don’t get to take any RE losses in that year. That said, any losses can be “carried over” and used in subsequent years, based on the same AGI criteria.

The benefit to declaring “Real Estate Professional” status is that all real estate losses can be claimed against income in that year, without limitation based on AGI.

So, if a part time investor (who makes less than $100,000 per year) racks up $75,000 in real estate losses in 2008, he can deduct $25,000 of those losses in each of 2008, 2009, and 2010. If he continues to rack up losses in 2009, 2010, etc, those losses will also have to be carried forward. In contrast, a Real Estate Professional in the same situation can deduct the full $75,000 against AGI in 2008, and can do so with the additional losses in subsequent years.

The big question for most investors is not “Do I want to declare Real Estate Professional status?” but “Can I legally declare Real Estate Professional status?”

The IRS rules for claiming Real Estate Professional Status are very clear, and require that two key criteria be met in the given tax year:

  1. More than half of the professional hours worked throughout the year must have been devoted to material participation in real estate activities;
  2. More than 750 hours of material participation in real estate activities in the tax year being considered.

If you think you can satisfy both of those criteria in a given year, I highly recommend working with your CPA or accounting professional to ensure that you properly document your time and efforts to allow you to claim Real Estate Professional status, and in return, keep more of your hard-earned profits.

For more information straight from the IRS, follow this link

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.