Real Estate Professional Status?

[Landon Hale]

I am looking for some clarity on the REP status. My main source of income is a full time W-2 job with a custom home building company (S-Corp). I am part owner of this company. I also have multiple investments as an LP in multi-family properties and I have 5 single family long term residential rental properties. The multi-family properties generate large paper losses most of which are suspended. I'm wondering if my participation in the home building company would meet the criteria for me to be classified as a REP, and if so would I be able to use some of the multi-family losses against all income? This is all new to me and I know it can get fairly complicated, so I'm just trying to see if this is an avenue worth exploring for me. Any feedback/advise is appreciated.

Thanks!

[Zachary Jensen]

Hey Landon, I only know of one tax court case where someone with a w2 was able to qualify as REPS. Do not try to qualify as a real estate professional with a w2. Perhaps if you happen to be married, consider options for your partner to become REP. 
A note on your sydications. Since you were NOT real estate pro during the time you had made those investments, those paper losses are passive and cannot be unlocked as active later. 
There are strategies that you could do to try to get future paper losses reducing your active income, but those require you to change your income-earning activities. Please keep in mind this is a very conservative interpretation of the law here (section 469). We just don't want our clients to face issues if they were ever audited and I'm giving you the same advice! 

[Michael Plaks]

Quote from @Landon Hale:

I am looking for some clarity on the REP status. My main source of income is a full time W-2 job with a custom home building company (S-Corp). I am part owner of this company.

How much of the company do you own, and what exactly do you do for the company?

[David M.]

@Landon Hale

Even though you have a w2 (there are all sorts), how many hours do you put in doing what?  Is that just the "reasonable salary" from an SCorp?

Of course, you probably should just consult your accountant.  I assume you have one for your returns.

I would just take a look and see if its tax efficient for you to do this.

If you qualify for REPS, you'd be able to take the passive losses that year onto your main 1040.  That's the income that it would offset.

[Landon Hale]

Quote from @Michael Plaks:

Quote from @Landon Hale:

I am looking for some clarity on the REP status. My main source of income is a full time W-2 job with a custom home building company (S-Corp). I am part owner of this company.

How much of the company do you own, and what exactly do you do for the company?

My understanding is you have to own at least 5% which I do. I run everything on the sales end and then some. So I office out of our model home daily. I meet prospects, draw plans, price custom homes, do the contracts, meet customers and sub contractors on site. 

[Landon Hale]

Quote from @Zachary Jensen:

Hey Landon, I only know of one tax court case where someone with a w2 was able to qualify as REPS. Do not try to qualify as a real estate professional with a w2. Perhaps if you happen to be married, consider options for your partner to become REP. 
A note on your sydications. Since you were NOT real estate pro during the time you had made those investments, those paper losses are passive and cannot be unlocked as active later. 
There are strategies that you could do to try to get future paper losses reducing your active income, but those require you to change your income-earning activities. Please keep in mind this is a very conservative interpretation of the law here (section 469). We just don't want our clients to face issues if they were ever audited and I'm giving you the same advice! 

Zachary, if I understand the requirements correctly(and it’s totally possible that I don’t) I believe I should meet the requirements of REPS easily with my activity in the home building company. But I’m thinking in order to use passive losses from other entities (multi family, SFR’s, etc) I would also have to show material participation in those activities in addition to the REPS, is that accurate? 

[Zachary Jensen]

Quote from @Landon Hale:

Quote from @Zachary Jensen:

Hey Landon, I only know of one tax court case where someone with a w2 was able to qualify as REPS. Do not try to qualify as a real estate professional with a w2. Perhaps if you happen to be married, consider options for your partner to become REP. 
A note on your sydications. Since you were NOT real estate pro during the time you had made those investments, those paper losses are passive and cannot be unlocked as active later. 
There are strategies that you could do to try to get future paper losses reducing your active income, but those require you to change your income-earning activities. Please keep in mind this is a very conservative interpretation of the law here (section 469). We just don't want our clients to face issues if they were ever audited and I'm giving you the same advice! 

Zachary, if I understand the requirements correctly(and it’s totally possible that I don’t) I believe I should meet the requirements of REPS easily with my activity in the home building company. But I’m thinking in order to use passive losses from other entities (multi family, SFR’s, etc) I would also have to show material participation in those activities in addition to the REPS, is that accurate? 

A misconception about the real estate professional status (REPS) is that you can be in a real property trade or business (in your case, home building company) and still qualify. 

To clear things up for you:

Rental real estate activities are default passive in the eyes of the IRS. Real estate professional status is valuable because it allows us to reclassify these rental activities to active. Why would we want to do that? Because if we can take deprecation losses from our rentals, we can use that loss to offset our other active income (from being a broker for example).

To qualify for real estate professional you need to

1. spend 750 hours working in a real property trade or business and more time in this then any other work activity.

2. Materially participate in your rental activities

How do we materially participate in our rental activities?

There is a test for that. Technically there are 7 ways, but for our purposes, we want to pass one of these three:

1. spend 500 hours materially participating in the rental activities

2. Spend 100 hours materially participating and more time then anyone else involved (cleaners, maintenance people etc)

3. Spend more time then anyone else doing all substantial services. (do ALL the work yourself)

What is "materially participating"? We take this to mean (based on 100s of real tax court cases) any activities integral to the business of running a rental. Meaning: if the business can function without you doing it, IT DOES NOT COUNT! Education and research hours, "managing the property manager" all have failed under audit historically.

There is a lot more nuance here I could go into, but I would strongly advice you talk with a real estate-focused tax professional. Not understanding and following the rules can cost you greatly. I hope this helps get your situation on the right track and gets the conversation going with your accountant.

[Michael Plaks]

Quote from @Landon Hale:

Quote from @Michael Plaks:

Quote from @Landon Hale:

I am looking for some clarity on the REP status. My main source of income is a full time W-2 job with a custom home building company (S-Corp). I am part owner of this company.

How much of the company do you own, and what exactly do you do for the company?

My understanding is you have to own at least 5% which I do. I run everything on the sales end and then some. So I office out of our model home daily. I meet prospects, draw plans, price custom homes, do the contracts, meet customers and sub contractors on site. 

Correct, 5% ownership is required, which is why I asked you. It is very likely (to be certain, I would have to interview you more thoroughly) that you do qualify for REPS just based off of your main work.

You are also correct that you're required to show material participation in your rentals and in your LP. With the rentals, it should be easy of you self-manage them. If you can show 500 hands-on hours with your 5 SFHs, then you probably can piggy-back your LP on them. Otherwise, it is very difficult or even impossible.

Details matter here, and knowledge matters here. The best thing of course is to consult an experienced tax pro and review your entire situation in depth.