W2 employee...filing real estate professional

12 Replies

I just had the privilege of going through my first tax audit and fortunately came out with a no change. However, I wanted to take a second to remind any investors who are still gainfully employed, and self manage their real estate portfolio, the importance of keeping a detailed ledger of their material participation in their business, i.e. per location, hours spent, as well as description of task. I assure you the 750 hours is just a bench mark and it will be scrutinized if you still have a W2 job or are not a licensed realtor.

@Lloyd Hudson . Can you be a little more specific on the word "self manage their portfolio" ? I own real estate assets and have property managers for each of them. However, I spend time working with my PMs to ensure they are doing their work as I expect them to (phone calls, meetings, emails, conference calls, ... etc). I also visit the assets as much as possible (I live max 25 miles away).  My assets are all in their respective LLCs. I don't have a real estate license, but have a W2 Job. In addition, I continue to investigate/analyze other potential assets. Are you saying I should document each one of these tasks and activities?

@Henri Meli .  It sounds as though we have a very similar situation.  In my case, the auditor wanted to verify my material participation as it pertained to each of the task I perform for my business.  The year in question, I had a restaurant,  storage facility and several rentals.  Thankfully, my accountant had conditioned me to keep track of the hours I spent at each specific location/task per day, because ultimately this is what the auditor was most interested in for my audit.  So in short, I do log all my specific task from book keeping, phone calls, driving for dollars, closings, bank deposits etc. and even get to add tax audit this year.  So no I am not a tax professional, but just went through this and wanted to pass it along for those who may be in a similar situation that may not be logging their time.    

@Henri Meli

Yes, you must keep a log of your time if you're going after the RE Pro status. More so - it must be a current log, not a reconstruction.

Before doing this, talk to an expert tax accountant specializing in REI. Discuss the PM issue. It could be a problem, and not because of your time, but because of the quirky "material participation" definition. I'm not saying you do not qualify, but I urge you to discuss it.

Keep in mind that tax returns with RE Pro designation are audited VERY regularly. The IRS has a special program targeting these returns.

@Lloyd Hudson - congrats on winning the audit and having a good accountant on your team. One note about your comments: being or not being a licensed agent has absolutely nothing to do with RE Pro status. The IRS usually states that it does, but it does not. Completely irrelevant.

Originally posted by @Lloyd Hudson :
I just had the privilege of going through my first tax audit and fortunately came out with a no change. However, I wanted to take a second to remind any investors who are still gainfully employed, and self manage their real estate portfolio, the importance of keeping a detailed ledger of their material participation in their business, i.e. per location, hours spent, as well as description of task. I assure you the 750 hours is just a bench mark and it will be scrutinized if you still have a W2 job or are not a licensed realtor.

Materially participating in an activity is not the same as being a real estate professional.  You may have passed the material participation tests and may have been able to deduct losses but you need to meet the 750 hours AND work more time in real estate than any other field to become a real estate professional. 

People who work as employees and self manage may meet the material participation tests but they will not likely meet the real estate professional tests.

@John Woodrich .  This is exactly the burden I had to prove. Ultimately, I was able to capture both aspects, due to having well over 1600's legitimate/verifiable time above and beyond my W2 job. 

Originally posted by @Lloyd Hudson :

@John Woodrich.  This is exactly the burden I had to prove. Ultimately, I was able to capture both aspects, due to having well over 1600's legitimate/verifiable time above and beyond my W2 job. 

I don't know anything about your audit but if you had a no change and claimed real estate professional it doesn't mean you were correct in calling yourself a real estate professional.  The no change only means there was not a tax change.  This was likely because you met the material participation tests which is NOT the same as the real estate professional tests.

He could write you up and say you were not a real estate professional however it would mean nothing if you were able to take your deductions under the material participation rules.

I am just pointing out that there is a difference between a real estate professional and someone who can deduct losses.  Your return was likely audited solely because you marked RE professional when you didn't qualify because of your W-2 or other reasons.

The information you provided is no grounds for anyone to go rouge and claim RE professional status.  Anyone who has multiple income streams and needs RE professional status should certainly be logging hours.  Most employees however will not qualify. 

Originally posted by @Lloyd Hudson :

@John Woodrich.  This is exactly the burden I had to prove. Ultimately, I was able to capture both aspects, due to having well over 1600's legitimate/verifiable time above and beyond my W2 job. 

If you worked 1600 verifiable hours in RE and worked 2080 being a full time employee you do not meet the RE professional status criteria.

A no change audit does not mean you were correct, it just means it isn't worth any effort of putting through a change that has no effect.

@John Woodrich  If it helps you, I stated I worked 1600 hours above and beyond my job hours. I did not go into the specifics of the audit or the vordiring, due to it not having any relevance to making sure people remember to keep track of their hours.  I retain a very compentent CPA for his expertise who specializes in real estate and cooperate accounting. It sounds as though you as well versed in this arena. Thanks for your input and clarification on the issue. 

I just wanted to make it clear for others.  If people have their ducks in a row like you did they will be OK in these audits.  As you mentioned it is VERY important to track time spent because it is impossible on the back end and the agent will not believe you.

@Lloyd Hudson

I can tell you why @John Woodrich felt a need to jump in. I share the same concern that John has. Your post can be easily misinterpreted as "RE Pro is not a big deal. I was audited, and I won - so you can, too!"

In reality, it is very difficult to defend RE Pro, particularly for W2 employees. In your case, one of the 3 things must have happened:

  1. you had an unusual case where you did qualify, despite W2 (but most people won't!)
  2. you had an incompetent IRS auditor who accepted it, even though you did not qualify (it happens, but don't count on it)
  3. you did not qualify as RE Pro, and the IRS did not concede it, but you still had no change in tax liability, even without RE Pro (sometimes possible, which was John's point)

Whichever it was - your case was NOT TYPICAL. Most people with W2s would not qualify, and those who do qualify must present a very strong and detailed time log.

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