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How to Avoid the #1 Most Common and Costly Tax Mistake as a Real Estate Investor

Amanda Han
3 min read
How to Avoid the #1 Most Common and Costly Tax Mistake as a Real Estate Investor

For anyone who filed an extension, this is the time of the year you are thinking about taxes again. It is scary to think that the average American loses more money to taxes each year than we do on food, clothing, and shelter COMBINED.  As scary as that sounds, there is a silver-lining to all this: As a real estate investor, you have the ability to control when and how much you pay to Uncle Sam. However, the tax benefits that are available to real estate investors do not “automatically” help you to save taxes. In fact, over the past decade, I have reviewed countless tax returns that cost investors thousands to tens of thousands of dollars in overpaid taxes because neither they nor their tax preparers know “how” to take advantage of all the real estate tax loopholes. As we head into the 2012 extension tax deadline, I wanted to take the opportunity to share with you the #1 Most Common and Costly Tax Mistake that you need to know as a real estate investor.

If you are a real estate investor, you must understand the Real Estate Professional Status and take advantage of the all the wonderful tax benefits relating to your investments. [Caution: Even if you have heard of the real estate professional status before…keep reading as you may be surprised to learn something new!] The “real estate professional status” loophole is what we see time and time again that helps taxpayers to decrease their taxes from tens of thousands of dollars down to ZERO. The reason that you want to qualify for the real estate professional status is because without the real estate professional status, your ability to actually benefit from your real estate tax deductions may be limited.  As a real estate professional, however, you get to take advantage of an unlimited amount of real estate deductions each year on your tax return.

Real Estate Professional Status, What is it?

So what exactly is this real estate professional loophole and how can you take advantage of it? Well, real estate professional, as defined by the IRS, actually has nothing to do with whether you are a licensed real estate agent or broker in your state. It has nothing to do with your education, professional licenses that you hold, or what type of business you are in. Rather, the IRS determines real estate professional status based on a set of different criteria. Simply put, the taxpayer (or spouse) only needs to meet both of the two following criteria in order to qualify for the tax benefits of being a real estate professional:

1) Spend more time in real estate activities than other “non-real estate” business activities combined

2) Spend at least 750 hours per year in real estate activities.

What You Need to Know to Benefit

Sounds easy enough? You may be shocked to learn that this simple tax loophole is by far the biggest and most common mistake that I see time and time again made by real estate investors. Let me share with you an example of someone I spoke with just last week.  Lynne has been working with a CPA for many many years and was always told she has been benefiting from the tax deductions as a real estate professional. When I reviewed her tax return, I had to be the bearer of bad new and let her know that her CPA prepared her taxes wrong and she lost out on $21,000 of a tax refund. The worst part of this was that there was nothing I could do after the fact to get that money back for her. Contrary to popular belief, the real estate professional status is not taken by simply indicating “real estate professional” as your occupation on page 2 of your tax return. It is also not a specific form to fill out with your tax return. To make things even more complicated, it is not even a particular box to check. Rather, it is an election that must be attached to your tax return at the time you file it. If you invest in real estate, make sure you speak to your tax preparer to ensure that election is in place before you send off that tax return.

The Good and Bad

The good news is: The average tax savings between a real estate professional and someone who is not a real estate professional is anywhere between $10,000 to $35,000 each and every year! The bad news is: if you make a mistake, it cannot be undone. The appropriate tax election must be attached to your original tax return at the time you file it…no amendments, no exceptions!

What Action Can Be Taken?

If you are a real estate investor and you have not spoken to your tax advisor about the benefits of this amazing loophole, you are probably overpaying your taxes. Contact your tax advisor TODAY to find out how you can plan ahead to take advantage of this powerful opportunity and start to save some significant tax dollars year after year!

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