IRS recognized real estate professional while drawing pension?

15 Replies

Hello - newbie here,

I'm a single high income earner so have very limited tax benefits for real estate investing and know that I cannot become an IRS recognized real estate professional while I have my W2 job. I plan to retire in 6 years and will have a pension. Would I then be able to become an IRS recognized full time real estate professional at that time while I'm drawing the pension? (would be under 100K threshold)And if so, would I be able to deduct depreciation at that time which has been deferred from previous years?

Thanks in advance for your response.

Originally posted by @Cristin Andrews :

Hello - newbie here,

I'm a single high income earner so have very limited tax benefits for real estate investing and know that I cannot become an IRS recognized real estate professional while I have my W2 job. I plan to retire in 6 years and will have a pension. Would I then be able to become an IRS recognized full time real estate professional at that time while I'm drawing the pension? (would be under 100K threshold)And if so, would I be able to deduct depreciation at that time which has been deferred from previous years?

Thanks in advance for your response.

Yes your can be RE pro. It’s a matter of putting in the time, pension has nothing to do with it. 

You need a passive income to offset those previously suspended loss or dispose the property. Just because you qualify for RE pro will not free up your previously suspended losses. 

New losses  after your qualify as RE pro on the rental that you materially participate can be deducted. If you don’t materially participate, even with the RE pro status, your loss will still be suspended. 

Key is the material participation. If you are a RE pro and you don’t participate materially in a rental, you can still deduct it under 25k active participation exception in your AGI is below 150, which you said your will be. 

@Christian Sifuentes

If you plan to retire in 6 years and making less than $100,000, you can potentially be eligible to utilize up to $25,000 of real estate losses in a year.
This depends on if you have other income(interest, dividends, etc). It also depends on your filing status.

It does become easier to classify yourself as a real estate professional once you leave your W-2. You qualify once you meet the 750 hours on real estate related activities.

@Cristin Andrews

My wife and I have put our rentals in a corporation to continue taking deductions over the 25k being high income as well. May want to check with a CPA to find out if you can set it up to take advantage before you retire. Good luck.

@Tony Vizzari

It is normally not suggested to hold property that can appreciate(IE Real Estate) within a Corporation.
You risk having the losses stuck in the Corporation that may potentially never be able to be utilized.

You may want to consult with another CPA.

@Tony Vizzari

Not only rentals should not generally be inside a corporation for tax reasons, as @Basit Siddiqi pointed out, but more importantly, you cannot legally sidestep the $25k rule with using entities. Any entities.

If you're doing it - you're breaking some rules in the process.

@Cristin Andrews

Let me repeat what already was said by others, in a slightly different way, and add couple more points:

1. It's correct that you cannot deduct your rental losses while being a high-income full-time W2 employee.

2. You still can (and must!) deduct depreciation. The resulting losses, including depreciation baked into these losses, are suspended until the future. 

3. These suspended losses are released when you sell a property, regardless of your income at the time of sale!

4. To qualify for RE Pro, pension does not matter, and neither does your total income level - as long as that income is not from working / providing services / selling something. You should be able to qualify if you spend enough time working on your rentals (minimum of 750 hours a year).

5. If you do qualify for RE Pro status, you old suspended losses are NOT released, only the current ones. Old suspended losses are released when you sell properties.

@Michael Plaks could you expand on what 'released' means please?

1) If I own a property that I sell for 500K, I bought 10 years ago for 400K and took 100K of depreciation that I have taken. I assume my taxable gain would be 200K. If I have 100K of suspended passive losses does that make my taxable gain100K?

2) Do those suspended passive losses need to be on the same property if I have multiple properties? Meaning do they tie to the taxpayer or property?

3)What happens if I pass way before selling? I assume my heirs would get a stepped up basis to 500K, so do they 'lose the tax benefit' of those suspended loses?

Thanks, Dan Dietz

Originally posted by @Daniel Dietz :

@Michael Plaks could you expand on what 'released' means please?

1) If I own a property that I sell for 500K, I bought 10 years ago for 400K and took 100K of depreciation that I have taken. I assume my taxable gain would be 200K. If I have 100K of suspended passive losses does that make my taxable gain100K?

Excellent questions, Dan. I will answer one at a time. 

Yes, you can think that your taxable gain is $100k in your example.

It is not entirely accurate though. The reality is better. You still have a $200k capital gain (of which $100k is depreciation recapture) and you also have a $100k ordinary loss from those suspended losses. The distinction is in your favor, because the loss goes against your non-RE income first, which could be at a higher rate than your capital gain rate. You win.

Originally posted by @Daniel Dietz :

@Michael Plaks could you expand on what 'released' means please?

2) Do those suspended passive losses need to be on the same property if I have multiple properties? Meaning do they tie to the taxpayer or property?

Yes and no.

Yes, because you only release losses attached to the property that has been sold. Example: Property A has $100k in suspended losses, and property B has $50k in suspended losses. You sell property A, so only the $100k gets unlocked/released. The $50k attached to property B is still suspended.

No, because the overall outcome could unlock the other losses, too, if there is enough capital gain. In the same example as above, assume that the capital gain on Property A is $200k, with depreciation recapture included. So you have $200k which counts as passive income. It is capital gain, but it's from a passive activity, so it counts as passive income. Of that $200k passive income, $100k is offset with the previously suspended $100k passive loss. And you still have $100k room left! Because of that, the $50k suspended loss from Property B suddenly gets unlocked, even though Property B itself has not been sold. Sweet!

Side note: which is why a 1031 Exchange is not always the right move!

Originally posted by @Daniel Dietz :

@Michael Plaks could you expand on what 'released' means please?

3)What happens if I pass way before selling? I assume my heirs would get a stepped up basis to 500K, so do they 'lose the tax benefit' of those suspended loses?

Now this is some advanced tax planning, Dan. Timing your demise is an art not commonly applied. :)

Yes, in this case you're correct: your heirs get a stepped-up basis. They cannot use the suspended losses because the losses are yours, not theirs.

Now, to the finer aspects of taxation. In your example, your adjusted basis is $300k. FMV is $500k, so your heirs get a $200k basis step-up. Your $100k suspended losses are lost.

However, let's change the numbers. Your adjusted basis is $300k, and the FMV is $400k rather than $500k. The heirs basis step-up is $100k. Let's assume you have $150k of suspended losses. The excess of your suspended losses ($150k) over the basis step-up ($100k), which is $50k in your case, is deductible on your final tax return. If you care, that is.

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