Real Estate Professional Tax Status - Help!

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Real Estate Professional Tax Status - Help!

Petur Karlsson
Rental Property Investor · Bucks county, PA · Member since 2019 · 58 posts · 24 votes

Hello everyone!

I'm knee deep in an lengthy rehab on my first BRRRR deal ever, in Sellersville, Bucks County PA.

The project started in late February, DAYS before the pandemic came around. Talk about good timing... Anyways, I accounted for the unforeseen and thankfully am still within budget, although the rehab is taking several more months than originally anticipated and the workload is massive to say the least. New floors (except 1st floor hardwood), attic conversion to master bed/master bad, new windows/doors, new bathroom, new kitchen, plaster removal, framing and drywall, painting, exterior brick repairs and soffit covering, new plumbing, new electric, THE WHOLE GAMBIT. Welcome to the university of real estate investing, I say.

I am putting in a lot of my own sweat equity and that, alongside with business meetings with the wife, networking with other investors and all the communications with my real estate agent, insurance agent, lenders, contractor and subcontractors, are accumulating to the point where I can likely achieve the 750 hours of real estate work required to designate myself as a "real estate professional" on our next year's tax return. This status allows me to write off all the real estate losses against our household income taxes. Terrific!

THE MOST IMPORTANT THING about claiming this status is to keep a detailed and contemporaneous log of all your activities, with supporting information like pictures, screenshots, etc. There are other things to consider, like NOT having any other work that exceeds the amount of time you spend on real estate activity (sorry investors with full time jobs, I'm lucky to be a stay at home dad). You also need to have at least 500 of those hours DIRECTLY related to the properties themselves. Please consult with a real estate CPA if you're planning on doing this, there are several other points to consider as well. (I also recommend The Book On Advanced Tax Strategies, found in the BP library) 

If you are a real estate professional already or have experience filing as one, HOW DO YOU LOG YOUR ACTIVITIES?

I use google calendar. I log everything same day (most of the time), try to be as detailed as possible and start each log stating participants and the entry's duration, and usually set my real estate home office address or the rehab property address as the location of the activity, unless it's a trip to the bank, Home Depot or an event/meeting elsewhere. 

Would you deem this to be an acceptable approach or should I convert to something else? I like this format and also print out every entry to store them in a physical folder. Both the virtual and physical log can be referenced in case I get audited by the IRS.

Another question I have is, WHAT ACTIVITY CAN BE COUNTED TOWARDS THE 750 HOURS REQUIRED? 

I consider the following: -Searching for properties, -analyzing properties, -working on properties, -marketing properties, -screening & communicating with tenants, agent/lender/insurance/contractor communications, -work on the real estate business itself like writing a business plan, contingency plan or company policy, -errands pertaining to the real estate like picking up materials or taking checks to the bank, -business meetings with my contractor and my wife who is obviously involved, -networking with other investors or attending real estate events. I also deem the writing of this post to be a real estate activity, correct me if I'm wrong?

A big question I have is: Do webinars count towards real estate activity? What about reading real estate books? HECK, WHAT ABOUT ENGAGING THE BP FORUMS? If anyone can answer these question, it would be massively helpful to me and other rookie investors who are looking to acquire this status. I've read a whole bunch of the BP books and spent quite a lot of time doing online research, but am too scared to involve those hours for eligibility.

If anyone wants to make any remarks or ask any questions pertaining to the real estate professional status, I welcome you to join the discussion! 

Thanks in advance for reading and/or responding, everyone.

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Natalie KolodijBusiness Member
Moderator
Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
6y

Hey peter I actually have a log available for this that Mimic's the IRS's audit guide they use when looking at hours. 

I won'tspam here on the forums but if you clicked through the links on my bigger pockets profile you'd find both that free log and also a you tube video on this topic that should both be really helpful to you. 

A lot of tax cases are lost when people are still working a full time job and trying to claim this- the more than any other activity comes into play. So if you work full time 2000 hours annually- you need at least 2001 in REI. It's hard with 1 house.

Only activities directly related to your property/ activity count. 


Your work on the house, repairing it, managing it as a rental, doing monthly financials, collecting rent ect. 


Networking, Meetings, ect don't count. Nor does time spent looking for other properties, researching ect. 

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  • Account Closed
    Contractor · San Diego, CA · Member since 2018 · 432 posts · 221 votes
    6y

    @Petur Karlsson hmmm... I was up in the air on whether to switch to this status for 2019. Definitely for 2020. My thoughts would be, how much household income could you have with your new status as an RE PRo? Do you really think the IRS is going to nitpick your first year hustling to be a real estate pro? There’s so much money, receipts and time that goes into a home flip, it doesn’t sound like you’d be on their radar for your first year trying to start a business without profits yet. Just thoughts, I’m learning!

    0Reply
  • Petur Karlsson
    OP
    Rental Property Investor · Bucks county, PA · Member since 2019 · 58 posts · 24 votes
    6y

    @Jonathan Greer our W2-income is enough for the real estate professional status to make sense, ESPECIALLY if I manage to convert our primary residence into a rental property before the end of the year as well (then buy a duplex for a house hack)!

    Be careful, though. The RE Pro tax status pertains to losses on RENTAL properties. FLIPS are active jobs with ordinary income and I'm not sure if the RE pro status is something eligible to flippers unless they also own rental properties.

    Also, I dont care if the IRS will pay attention to me or not, I want to be legit and do things correctly and legally out of principal and with long term success in mind.

    0Reply
  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    6y

    @Petur Karlsson

    You seem to have a lot of the bases covered. You even understand passive vs active/ordinary income.

    Have you considered that more than half of your time has to be in real estate activities? So, you have to spend more time doing real estate than your w2 job. That’s generally pretty tough.

    What passive losses are you intending on deducting onto your 1040? You realize all your work/cost to fix up your rental sounds like it will go into the cost basis. It’s not in service so you aren’t a passive investor. And you can’t “charge/deduct” for swear equity as I recall.

    You are trying to make money on your rentals, right?

    Meanwhile, depreciation is a nice non-cash deduction, you will pay tax on it later. So having some carryover losses isn’t always a bad thing.

    Good luck

    2Reply
  • Wayne Brooks
    Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
    6y

    @Petur Karlsson What losses are you looking to take advantage of? If you're doing all this work on the property yourself, or any decent rental property for that matter, you shouldn't Have any losses to worry about using against your wife's w-2 income. Of course, all the rehab/fix up money you're spending on this BRRR house aren't expenses/losses on your taxes....they just add to your basis in the property.

    0Reply
  • Account Closed
    Contractor · San Diego, CA · Member since 2018 · 432 posts · 221 votes
    6y

    @Petur Karlsson thanks for the info on RE Pro status. Sounds like you’re doing your homework.

    0Reply
  • Petur Karlsson
    OP
    Rental Property Investor · Bucks county, PA · Member since 2019 · 58 posts · 24 votes
    6y

    Wayne and David, 

    thank you for the responses, I very much appreciate your input.

    I know the rehab costs get added to the cost basis of the property and will be depreciated rather than discounted as operating expenses, but I want the real estate professional status for two reasons.

    1) I can't use depreciation to offset income tax without it, as our household income exceeds the IRS limit for real estate deductions.

    2) There are many other things to write off, such as taxes, insurance, subscriptions, meals, books, phone & internet bills, miles driven for real estate errands, office supplies, home office deduction, etc.

    However, maybe it's not that important for me to achieve the real estate professional status this year, as I have just learned that I can carry the losses forward into next year and stay focused on achieving the status by the end of 2021. I just reformed the way I log everything and am more disciplined with saving supporting evidence like screenshots of texts, emails, call logs, pictures, etc. so the main argument for shooting for the real estate professional status is that it helps you to stay focused and continually improve your methods.

    I will have to find a good CPA to help me navigate all of this, have you guys got any recommendations for real estate focused CPA's that work across state borders including PA?

    1Reply
  • Natalie KolodijBusiness Member
    Moderator
    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    6y

    Hey peter I actually have a log available for this that Mimic's the IRS's audit guide they use when looking at hours. 

    I won'tspam here on the forums but if you clicked through the links on my bigger pockets profile you'd find both that free log and also a you tube video on this topic that should both be really helpful to you. 

    A lot of tax cases are lost when people are still working a full time job and trying to claim this- the more than any other activity comes into play. So if you work full time 2000 hours annually- you need at least 2001 in REI. It's hard with 1 house.

    Only activities directly related to your property/ activity count. 


    Your work on the house, repairing it, managing it as a rental, doing monthly financials, collecting rent ect. 


    Networking, Meetings, ect don't count. Nor does time spent looking for other properties, researching ect. 

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  • Petur Karlsson
    OP
    Rental Property Investor · Bucks county, PA · Member since 2019 · 58 posts · 24 votes
    6y
    Originally posted by @Natalie Kolodij:

    Hey peter I actually have a log available for this that Mimic's the IRS's audit guide they use when looking at hours. 

    I won'tspam here on the forums but if you clicked through the links on my bigger pockets profile you'd find both that free log and also a you tube video on this topic that should both be really helpful to you. 

    A lot of tax cases are lost when people are still working a full time job and trying to claim this- the more than any other activity comes into play. So if you work full time 2000 hours annually- you need at least 2001 in REI. It's hard with 1 house.

    Only activities directly related to your property/ activity count. 


    Your work on the house, repairing it, managing it as a rental, doing monthly financials, collecting rent ect. 


    Networking, Meetings, ect don't count. Nor does time spent looking for other properties, researching ect. 

     Thank you very much for the response, Natalie!

    I am a stay at home dad with no employment otherwise, so I don't have to cover more than 750 hours of real estate work to qualify for the real estate professional status. I am reading the book on advanced tax strategies, sold here in the bigger pockets library and written by Real Estate Expert CPA's, and the book states that I can do various real estate specific work NOT directly related to the rental property and STILL qualify the hours for the status, as long as at least 500 of those hours are directly connected to it. I'm surprised that you tell me this is incorrect, or am I misunderstanding what you are saying?

    I am logging phone calls and emails to subcontractors, lenders, insurance agents, bookkeeping sessions related to my real estate (the one property), drives to and from the property for rehab work sessions (I have a home office so its going from Business location A to business location B) and more things that you could easily claim are related to my investment property. I have business meetings with my wife who is directly involved in the decision making for the property as well as my contractor who manages the rehab with me. You don't think those meetings qualify if they are always about the property? Discussing my property here on Bigger Pockets should also qualify for consultations directly related to the property or would you say that is a stretch? I've applied the information directly to it as a result.

    Thanks again for your insightful response.

    0Reply
  • Natalie KolodijBusiness Member
    Moderator
    Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
    6y
    Originally posted by @Petur Karlsson:
    Originally posted by @Natalie Kolodij:

    Hey peter I actually have a log available for this that Mimic's the IRS's audit guide they use when looking at hours. 

    I won'tspam here on the forums but if you clicked through the links on my bigger pockets profile you'd find both that free log and also a you tube video on this topic that should both be really helpful to you. 

    A lot of tax cases are lost when people are still working a full time job and trying to claim this- the more than any other activity comes into play. So if you work full time 2000 hours annually- you need at least 2001 in REI. It's hard with 1 house.

    Only activities directly related to your property/ activity count. 


    Your work on the house, repairing it, managing it as a rental, doing monthly financials, collecting rent ect. 


    Networking, Meetings, ect don't count. Nor does time spent looking for other properties, researching ect. 

     Thank you very much for the response, Natalie!

    I am a stay at home dad with no employment otherwise, so I don't have to cover more than 750 hours of real estate work to qualify for the real estate professional status. I am reading the book on advanced tax strategies, sold here in the bigger pockets library and written by Real Estate Expert CPA's, and the book states that I can do various real estate specific work NOT directly related to the rental property and STILL qualify the hours for the status, as long as at least 500 of those hours are directly connected to it. I'm surprised that you tell me this is incorrect, or am I misunderstanding what you are saying?

    I am logging phone calls and emails to subcontractors, lenders, insurance agents, bookkeeping sessions related to my real estate (the one property), drives to and from the property for rehab work sessions (I have a home office so its going from Business location A to business location B) and more things that you could easily claim are related to my investment property. I have business meetings with my wife who is directly involved in the decision making for the property as well as my contractor who manages the rehab with me. You don't think those meetings qualify if they are always about the property? Discussing my property here on Bigger Pockets should also qualify for consultations directly related to the property or would you say that is a stretch? I've applied the information directly to it as a result.

    Thanks again for your insightful response.

     Different CPA's will interpret things diffidently. 

    The book also took the stance that to claim the 199A deduction you essentially had to utilize the safe harbor which every CPA who's on the BP forums took the opposite stance on. 

    It was my understanding that if you're using rentals to qualify- your time needs to be related TO the existing rentals. Not the research, obtaining, or sourcing of new properties. It's possible there's something I'm missing as well. 

    @Amanda Han

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  • Amanda HanPro Member
    Accountant · Fullerton, CA · Member since 2009 · 106 posts · 68 votes
    6y

    Hi guys: thanks for inviting me to comment on here. Yes material participation time needs to be related to properties owned although that is slightly different from RE professional time which can include RE time that are not specifically related to RE properties owned. There is a great article that the Journal of Accountancy published which has an Exhibit of 2 circle diagrams that they use to demonstrate the relationship between RE professional time and material participation time as well as the 7 tests to meet material participation.  Yes for someone who is working full-time, you will definitely want to make sure you have solid documentation to substantiate REP status as that is something the IRS would likely challenge IF the return is selected for audit. So if you are planning to claim that, I would certainly create and document more that the minimum required hours..the more hours you spend the better it is in case an auditor throws out some of the hours in examination.  Hope this helps =)

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  • Stephen MahlerPro Member
    Member since 2018 · 45 posts · 26 votes
    5y

    @Petur Karlsson

    Hey Peter, I am also a real estate investor in Pa. I am looking into having my wife qualify as a real estate professional this year. We have three rentals and another one under contract. We also manage the rentals ourselves.

    Let me know if you find a good real estate focused CPA. i have used CPAs the last two years but they are not soley focused in real estate so i may be missing some tax benefits.

    I would also like to know if we can count researching new properties, analyzing properties, real estate education(webinars, books, bp articles/forums, YouTube videos, etc.), communication with lenders. Contractors, other investors, wholesalers, insurance agents, etc.

    Great thread, im looking forward to hearing from more professionals on this topic

    2Reply
  • Bonnie Griffin KaakePro Member
    Real Estate Consultant · Denver, CO · Member since 2021 · 661 posts · 389 votes
    5y

    @Stephen Mahler Unfortunately, the list of activities you mention in your post do not count toward hours for RE Professional qualification. If your wife does not work a W2 job and is actively managing your investment properties, she may likely qualify as a RE Professional. She would have to meet the 750 hours requirement (all properties combined if grouped) and material participation requirements. 

    [email protected]303-475-4459
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  • Bonnie Griffin KaakePro Member
    Real Estate Consultant · Denver, CO · Member since 2021 · 661 posts · 389 votes
    5y

    @Wayne Brooks  In the thread above, you mentioned that rehab and fix-up money goes to your basis. That does not have to happen if you do the changes in any year other than the same year you buy the property. To be compliant with the Tangible Property Regulations (TPRs), a lot of this can be expensed. Also, under TPRs and by doing a cost segregation study, you can do a Partial Asset Disposition and write off as a loss the items you remove from the property that would be included in the original basis.   

    [email protected]303-475-4459
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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    5y
    Originally posted by @Stephen Mahler:

    @Petur Karlsson

    Hey Peter, I am also a real estate investor in Pa. I am looking into having my wife qualify as a real estate professional this year. We have three rentals and another one under contract. We also manage the rentals ourselves.

    Let me know if you find a good real estate focused CPA. i have used CPAs the last two years but they are not soley focused in real estate so i may be missing some tax benefits.

    I would also like to know if we can count researching new properties, analyzing properties, real estate education(webinars, books, bp articles/forums, YouTube videos, etc.), communication with lenders. Contractors, other investors, wholesalers, insurance agents, etc.

    I assume you found a real estate accountant by now. If not - you're on a forum where 20+ of us regularly answer questions. Just browse the forum, and you should find more than one expert to choose from.

    There's no black-and-white answer to your question, except that education and research do not count. Communication with lenders, contractors etc. would count if it concerns a specific property that you acquired. If it's general networking - then most likely no. But the line is blurry, and interpretations vary from one tax pro to another and even from one court case to another.

    Here's an informal test. Imagine you hired a project manager. Would you pay for his time spent on a particular activity? If yes, it's more likely to be of the kind that counts for REP status.

    2Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    5y
    Originally posted by @Bonnie Griffin Kaake:

    @Wayne Brooks  In the thread above, you mentioned that rehab and fix-up money goes to your basis. That does not have to happen if you do the changes in any year other than the same year you buy the property. To be compliant with the Tangible Property Regulations (TPRs), a lot of this can be expensed. Also, under TPRs and by doing a cost segregation study, you can do a Partial Asset Disposition and write off as a loss the items you remove from the property that would be included in the original basis.   

    Year does not matter. What matters is when the property is placed in service, i.e. when the initial rehab is completed. The discussion on this thread focused on the initial rehab, before the property was placed in service. Tangible property regulations do not apply to such situation. They would apply to future repairs/improvements, after the property is in service. Whether it happens in the year of purchase or in a later year does not matter. So, Wayne is right.

    Cost segregation is a separate game from TPR. Yes, items qualified as personal property could be separated from the other rehab costs and deducted in the year the property placed in service. Partial dispositions is yet another game, also separate from TPR.

    1Reply
  • Bonnie Griffin KaakePro Member
    Real Estate Consultant · Denver, CO · Member since 2021 · 661 posts · 389 votes
    5y

    @Michael Plaks  You are correct that if the property is not yet in service and you do the fix-up, it does change the situation and it gets added to the basis. On the other hand, if there was occupancy prior to the renovations, and they are being done a year after that occupancy/purchase, a Partial Asset Disposition, which is part of the Tangible Property Regulatons, can be done. This is a complex and specialty area of tax law that we teach CPAs and tax professionals about in CPE classes. Cost segregation can only be done after a property is placed in service. I did not see anywhere where the person mentioned that the fix-up/rehab was being done prior to occupancy or that there was or was not occupancy when the property was purchased. Maybe I missed that point. That is why I responded the way I did. I really don't like seeing investors pay more in taxes than they need to pay. 

    [email protected]303-475-4459
    1Reply
  • Petur Karlsson
    OP
    Rental Property Investor · Bucks county, PA · Member since 2019 · 58 posts · 24 votes
    4y

    @Michael Plaks

    Hey Michael, I managed to qualify for the REP status in 2020, Nick Aiola is my cpa and was instrumental in helping me understand all the rules and requirements and he also filed my return with the REP designation.

    His business is Aiola CPA PLLC, I highly recommend his services since I used his monthly email exchange subscription to constantly bounce off thoughts and ideas on everything real estate related within his scope of expertise, and let’s just say it saved me from A LOT of googling haha..

    1Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    4y
    Originally posted by @Petur Karlsson:

    @Michael Plaks

    Hey Michael, I managed to qualify for the REP status in 2020, Nick Aiola is my cpa and was instrumental in helping me understand all the rules and requirements and he also filed my return with the REP designation.

    His business is Aiola CPA PLLC, I highly recommend his services since I used his monthly email exchange subscription to constantly bounce off thoughts and ideas on everything real estate related within his scope of expertise, and let’s just say it saved me from A LOT of googling haha..

    With my good friend @Nicholas Aiola, you're in good hands.

    1Reply
  • Nicholas AiolaBusiness Member
    CPA & Investor · New York, NY · Member since 2017 · 1k+ posts · 1k+ votes
    4y

    Thanks @Petur Karlsson and @Michael Plaks !

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  • Account Closed
    Investor · Scottsdale Austin Tuktoyaktuk · Member since 2021 · 4k+ posts · 4k+ votes
    4y
    Originally posted by @Nicholas Aiola:

    Thanks @Petur Karlsson and @Michael Plaks !

    I understand that one shouldn’t put rentals in an S Corp. This actually pertains to an unexpected flip.

    Generally; if an investor meets real estate professional requirements and has multiple rentals in single member LLCs, taxed as disregarded entities and has no W2 income, no S Corp, just LLCs

    1. and then a property is bought & added within a LLC that has rentals in it already with the intention to hold it as a rental, BUT after rehabbing, it's decided to flip the property instead . . . (long story) ;-)

    2. If the net profit after expenses is $100,000 does it make sense to tax that LLC as an S Corp even though there are a couple of other rentals in the LLC, or does that cause problems? The intent is for the LLC to cash flow & eventually pass to the kids for the stepped up tax basis.

    a. Can you treat an LLC as a S-Corp one year for tax purposes and as a disregarded entity the next year?

    b. For 1031 purposes, does a property being in an LLC treated as an S Corp prevent that property from being in a 1031 exchange?

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