Cost segregation/ real estate professional status

[Oliver Cordova]

I was consulting with cost segregation company. This is what she told my CPA

'if you do not fit the qualifications to be considered a real estate professional, then passive income limitations would not allow you to access the deductions'

I have never heard or read anything as such. I remeber hearing if you make too much on your W2 then it might not benefit you from cost segregation. 

Any advice would be greatly appreciated.

[Ryan Coon]

Hi Oliver, what the cost seg company is likely getting at is that if you do a cost seg on a property the losses generated by the cost seg will be passive losses and thus can only offset other passive income (as opposed to active income such as w2 income), unless you are somehow able to get shift the losses from the cost seg to qualify as active losses. There are two primary means to have the losses from the cost seg qualify as active losses.

First, you can qualify as a real estate professional. This would allow the losses from depreciation on any or all of your investment properties, including those losses generated a cost seg, to offset other active income. Qualifying as a real estate professional can be an uphill battle, in particular if you are working a full-time W-2 job. One of the workarounds here is that if you are married and one spouse is a high W-2 income earner, as long as you are filing taxes jointly, the other spouse can qualify as a real estate professional to offset W-2 income of the high income earning spouse.

Second, you could fit into what is often referred to as the "short-term rental loophole". This involved renting a property out as a short-term rental and also meeting the "material participation" test for that specific property. If you can meet these requirements then you can do a cost seg on that specific property and have those losses offset other active income. As you can see, the short-term rental loophole is more limited in scope because it only allows the depreciation/cost seg on that specific property to offset active income. However, the material participation test is generally much easier to hit than qualifying for real estate professional status, especially if you have a full-time W-2 job.

In summary, if the intent is to use losses generated by the cost seg to offset active income, then the cost seg company is correct in that you either need to qualify as a real estate professional, or fit into the short-term rental loophole in order for the losses from the cost seg offset the desired active income. If, however, you're simply planning on using the losses from the cost seg to offset passive income, you do not need to need to be a real estate professional or fit into the short-term rental loophole.

Note: This information is for educational and informational purposes only and does not constitute legal, tax, or financial advice. No attorney-client, fiduciary, or professional relationship is established through this communication.