Material Participation in Rental Real Estate

5 Replies

Under Sec 469:

  • A taxpayer qualifies as a real estate professional if (1) more than one-half of the personal services the taxpayer performs in trades or businesses during the tax year are in real property trades or businesses in which the taxpayer materially participates, and (2) hours spent providing personal services in real property trades or businesses in which the taxpayer materially participates total more than 750 during the tax year.
  • A rental activity of a taxpayer that qualifies as a real estate professional under Sec. 469(c)(7) is not presumed to be passive and will be treated as nonpassive if the taxpayer materially participates in the activity.

If someone qualifies as a real estate professional, he/she can deduct I believe up to $25,000 of rental losses per year against ordinary income. So, does that mean that rental income will be classified as ordinary income too (vs investment income which is taxed at a lower rate)?

Thank you!

Originally posted by @Michelle Au :

Under Sec 469:

  • A taxpayer qualifies as a real estate professional if (1) more than one-half of the personal services the taxpayer performs in trades or businesses during the tax year are in real property trades or businesses in which the taxpayer materially participates, and (2) hours spent providing personal services in real property trades or businesses in which the taxpayer materially participates total more than 750 during the tax year.
  • A rental activity of a taxpayer that qualifies as a real estate professional under Sec. 469(c)(7) is not presumed to be passive and will be treated as nonpassive if the taxpayer materially participates in the activity.

If someone qualifies as a real estate professional, he/she can deduct I believe up to $25,000 of rental losses per year against ordinary income. So, does that mean that rental income will be classified as ordinary income too (vs investment income which is taxed at a lower rate)?

Thank you!

 Hey, kudos for doing your research. We need to clear few things  here. 

1) You don’t need to be RE pro to deduct 25k of rental loss. You can deduct if your AGI is less than 100k, and can deduct partially until your reach 150k. After 150k, you can’t dedcut. 

The RE pro can deduct the loss without any limitations. 

And, No, the rental income will not be ordinary income. But you have to understand that both Passive income and Ordinary income is taxed as same rate. 

IRS came up with passive income as a category just to make sure people were not deducting passive loss against ordinary income. 

2) thus, rental income is not taxed as lower rate.  You are thinking about the capital gain/qualified dividend that’s is taxed at lower rate. 

Rental income is passive but still taxed at ordinary income rate. 

This is confusing if you are not dealing with this everyday. 

@Ashish Acharya Thank you! This is really helpful. Just one more follow up. If I become a RE professional and  one day I sell my rental real estate properties that I have held for over 1 year for gains. Will the gains be classified as long term capital gain and taxed at a lower rate?

Originally posted by @Michelle Au :

@Ashish Acharya Thank you! This is really helpful. Just one more follow up. If I become a RE professional and  one day I sell my rental real estate properties that I have held for over 1 year for gains. Will the gains be classified as long term capital gain and taxed at a lower rate?

 Yes, once you hold your property for more than a year, you will get a capital gain treatment. 

But remember, when you sell, part of the gain is taxed maximum 25% rate. It’s called depreciation recapture. 

Originally posted by @Michelle Au :

@Ashish Acharya Thank you! This is really helpful. Just one more follow up. If I become a RE professional and  one day I sell my rental real estate properties that I have held for over 1 year for gains. Will the gains be classified as long term capital gain and taxed at a lower rate?

It will happen regardless of whether or not you qualify for RE Pro.