Should I be a real estate professional status for tax purposes?

7 Replies

What are the downsides of electing to be treated as a real estate professional for taxes? Would this make my real estate rental income become active income instead of passive? Is this taxed differently? I do not have high income from other areas of work and my rentals all cash flow positively even after depreciation so I do not show any real estate losses that would offset income from other areas.

I am also a real estate agent, but only do half a dozen deals a year. Would this automatically make me have to be treated as a real estate professional?

Originally posted by @Kip Cline :

What are the downsides of electing to be treated as a real estate professional for taxes? Would this make my real estate rental income become active income instead of passive? Is this taxed differently? I do not have high income from other areas of work and my rentals all cash flow positively even after depreciation so I do not show any real estate losses that would offset income from other areas.

I am also a real estate agent, but only do half a dozen deals a year. Would this automatically make me have to be treated as a real estate professional?

You have to first meet the requirements to be a pro. Requirements are mostly based around hours so just having a license wouldn’t make you a pro. 

If you are a pro, then it would only be helpful if you had passive losses.  But it you were in the higher tax bracket, and if your income was subject to NIIT tax, you would avoid those if you could structure and run your rentals in certain way. 

@Kip Cline you will need to carefully document the hours to make sure you can prove the compliance with the requirements. But it's very helpful if you can. You will get to deduct your real estate losses. You can do cost segregation to increase your depreciation costs. It's worth your time to fully investigate this.

Christian

@Christian Stoecklein

Is the real estate professional election optional? I do meet the requirements, but was wondering if it would be beneficial or detrimental in my circumstance.

Would my rentals be considered active income or passive? I spend more hours on my rentals than the other streams of income combined. My other streams include real estate agent commissions and I do property preservation for bank foreclosures. I have not had real estate losses, primarily because the properties I invest in are under $50k and cash flow well. I do not feel it would be cost effective to have a cost segregation on them.

If your AGI is under 330k you will not see much impact from doing REP - using passive losses to offset ordinary income. You might want to elect to save passive losses for the future when your AGI is higher and in higher tax brackets.

@Kip Cline   The RE Professional classification can change passive income into active. Nevertheless, there are strict requirements and tend to be a red flag for IRS audits. When and if audited, the vast majority are overturned. Keeping detailed records of time, as others have mentioned, is critical. Also, if you have ANY W2 income, you are on shaky ground with the IRS. In addition, talk to your CPA/tax professional about grouping your properties so that passive gains on one can offset passive losses on others. If you have STRs and prove "material participation", they are automatically active since they are considered a business and depreciated over 39 years instead of 27.5. No matter what commercial or residential rental property you invest in, if you paid over $200k for it, you will want to take advantage of cost segregation and leverage the Tangible Property Regulations. 

Originally posted by @Lane Kawaoka :

If your AGI is under 330k you will not see much impact from doing REP - using passive losses to offset ordinary income. You might want to elect to save passive losses for the future when your AGI is higher and in higher tax brackets.

I am not sure if I agree with this.
There is a difference between AGI and Taxable income in that you normally are eligible to deduct items such as itemized deductions/standard deduction/QBI deduction.

However, a single taxpayer making around $300,000 in taxable income is at the 35% tax bracket
A joint filer around $300,000 in taxable income is taxed at 24%

35% is not far off from the highest tax rate of 37%

Furthermore, you are not only just saying 35% or 24% in taxes if you live in a state that recognizes REP status.

One con of claiming REP status is that you may need to elect the 'grouping election'.

There are cons to the grouping election if you decide to sell individual properties in the future where there is suspended passive losses prior to being eligible for REP status.