What Investors Should Know About Qualifying As a “Real Estate Professional” For Tax Purposes


My investor clients like to ask about qualifying for the real estate professional status, which allows the deductibility of passive losses against ordinary income on tax return without limits. There is much confusion surrounding the real estate professional status, especially in what can and cannot count toward the hour requirement.

To meet the real estate professional status requirements, you must work at least 750 hours in a real estate trade or business, and more than half of your annual working hours must be in that real estate trade or business (if you work a full-time job, you won’t qualify as a real estate professional because you’d have to work more hours in your real estate business than you do at your job for the year). After that, you must prove that you materially participated in your rental activities, but this discussion in beyond the scope of this article.

After I tell clients about the 750-hour requirement, the next logical question is, “What qualifies?” Often there is a discussion of whether or not research and education hours qualify because those hours, in the client’s eyes, are essential for the growth of their business.

At the end of June 2015, we received some guidance in terms of research hours. A tax court case, Padilla vs. Commissioner of Internal Revenue, determined that hours spent researching new listings, such as existing rentals and foreclosures, are investment activities in nature, meaning that you cannot count these hours toward the 750-hour requirement. Additionally, the case inherently highlights the importance of keeping accurate hour logs separate of other business activities and being able to substantiate the recorded hours.

More importantly, the case provides the IRS with ammo to stipulate that if your properties are managed by a property manager, you are likely not going to meet the 750-hour requirement.

Related: How an Investor Missed a $100K+ Tax Deduction (& How You Can Avoid This Costly Error!)

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Please see a real estate savvy CPA or tax accountant prior to taking on a more aggressive tax position. You don’t want to be caught with a huge back-tax bill that includes penalties and interest.

Here is the text of the case (I’ve bolded key phrases):


Petitioners (aka defendant) resided in California when their petition was filed. Petitioners were employed during 2010 and, together, earned wages totaling $131,368. They owned five single-family rental properties, one of which was in San Francisco, California, and two each of which were in Round Rock and Pflugerville, Texas, respectively.

On their 2010 Schedule E, Supplemental Income and Loss, petitioners reported: gross rental income totaling $72,790, expenses totaling $81,693, and depreciation totaling $21,243, all of which resulted in a net loss of $30,146. Petitioners deducted the $30,146 reported net loss from their wage and other income.

IRS, in a notice of deficiency dated September 26, 2012, among other adjustments, disallowed $28,694 of the claimed rental activity loss deduction, because, according to respondent, the losses were passive activity losses.

Jerome Padilla (petitioner) was a finance professional who managed companies’ budgets and financial reporting. He purchased a single-family residence during 2000 and four additional single-family residences during 2005-06. During 2006 when the real estate market was good, petitioner decided to pursue a rental real estate activity. The company Petitioner worked for was restructuring and downsizing during 2009, and in April 2010 Petitioner lost his job. Petitioner worked approximately 676 hours for the company during 2010 until his employment was terminated.

The loss of his job, coupled with an overall economic downturn in the real estate market, caused Petitioner to spend more time in trying to refinance and in other activity related to his rental properties. He also spent time considering alternatives, including opening a self-storage business, acquiring more single family homes, and opening a wine bar.

During 2010 Petitioners’ four rental houses in Texas were managed by Gaynor Property Management Co., LLC (Gaynor). Gaynor provided complete management of the Texas properties and would consult with petitioners regarding any needed repairs or maintenance or other aspects involving the rental activity. If a repair or maintenance was agreed upon, Gaynor would hire the contractor to do the work. Petitioner was more involved in the San Francisco rental property but also hired a real estate company to handle the rental activity and to oversee repairs.

Petitioner prepared a summary document that purported to reflect 764 hours worked in his rental activity. Several of the items in the summary related to 37 spent hours researching new business investment opportunities, including opening a wine bar and a self-storage facility. Numerous hours were spent “Research[ing]Existing Property Locations”, which included searching for new real estate investments near the five rental properties. Numerous hours were spent considering “Refinance” of existing properties.


The primary dispute in this case is whether petitioner was engaged for at least 750 hours as a real estate professional in his rental real estate activity. IRS contends that Petitioners fail to meet the test to be entitled to use losses from a rental real estate activity against non-passive income, for the following reasons: (1) the 750-hour test was not met because the log included non-rental activity and/or investor activity; (2) petitioners did not properly elect to treat all rental activity as one activity; and (3) petitioners failed to adequately substantiate the number of hours spent in the activity.

Generally, the taxpayer bears the burden of proving entitlement to any deductions claimed. This burden may shift to the Commissioner if the taxpayer introduces credible evidence with respect to any relevant factual issue and meets other conditions, including maintaining required records. Petitioners have not established their compliance with section 7491(a). Accordingly, petitioners bear the burden of proof.

Taxpayers are allowed deductions for certain business and investment expenses; however, section 469(a) generally disallows any passive activity loss. Passive activity losses can be deducted only to the extent of passive activity gains in a particular tax year, and the remaining passive activity losses are suspended and may be carried forward to subsequent tax years. Sec. 469(b). Passive activity losses can be deducted from passive activity gains and ordinary income when the underlying passive activity property is disposed of.

A passive activity loss is defined as the excess of the aggregate losses from all passive activities for the taxable year over the aggregate income from all passive activities for that year. A passive activity is any trade or business in which the taxpayer does not materially participate or to the extent provided in regulations, any activity with respect to which expenses are allowable as a deduction under section 212, sec. 469(c)(6)(B).

Rental activity is generally treated as a per se passive activity regardless of whether the taxpayer materially participates. Material participation is defined as involvement in the operations of the activity that is regular, continuous, and substantial. An exception to the rule that a rental activity is per se passive is found in section 469(c)(7), which provides that the rental activities of a taxpayer in real property businesses are not per se passive activities under paragraph (2) but are treated as a business subject to the material participation requirements of paragraph (1).

A taxpayer may qualify as a real estate professional if: (1) more than one-half of the personal services performed in trades or businesses by the taxpayer during the taxable year are performed in real property trades or businesses in which the taxpayer materially participates and (2) the taxpayer performs more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates.

For purposes of determining whether a taxpayer is a real estate professional, a taxpayer’s material participation is determined separately with respect to each rental property unless the taxpayer makes an election to treat all interests in rental property as a single rental real estate activity. Petitioners did not show that they made an election to treat their five rental properties as a single activity.

The extent of an individual’s participation may be established by any reasonable means. Contemporaneous daily time reports, logs, or similar documents are not required if the extent of such participation may be established by other reasonable means. Reasonable means  include but are not limited to the identification of services performed over a period of time and the approximate number of hours spent performing such services during such period, based on appointment books, calendars, or narrative summaries.

We reviewed petitioner’s log coupled with his testimony to determine whether the activities listed constituted “material participation”. Petitioner spent at least 37 hours researching new business investment opportunities, including opening a wine bar and a self-storage facility. The other categories of monthly activities included property and rental management representing less than one-half of the hours for each month. Most of the hours for each month were in the following generic categories: research properties near properties already owned; refinance research; foreclosure research (which appears to be considering properties that could be purchased); and researching new businesses.

Petitioner hired a management company to manage the four Texas properties. Additionally, he hired a real estate company to find tenants and lease the San Francisco property. Accordingly, petitioner had relatively little personal involvement in the operation of the rental real estate activity that was regular, continuous, and substantial.

Work done by an individual in the capacity of an investor in an activity is not generally treated as participation in the activity. Most of the items listed in petitioner’s log are more in the nature of work done by an individual in the capacity of an investor.

For example, researching properties near the existing properties and foreclosure research to acquire new properties were investor activities. They were not activities involving petitioner in the operation of his existing rental real estate activity, such as finding tenants, making or overseeing repairs, etc.

Accordingly, petitioners’ argument must fail because they have not shown that at least 750 hours were spent involved in the rental real estate activity, as opposed to investor activities. We accordingly hold that petitioners have failed to show entitlement to deduct their passive losses from non-passive income and/or that respondent’s determination was in error.

What do you think about this court case? Have any questions about qualifying as a real estate professional for tax purposes?

Leave your comments below!

About Author

Brandon Hall

Brandon Hall, owner of The Real Estate CPA, is an entrepreneur at heart who happens to be good at taxes. Brandon is a real estate investor and CPA specializing in providing business advice and creative tax strategies for real estate investors. Brandon's Big 4 and personal investing experiences allow him to provide unique advice to each of his clients. Sign up for my FREE NEWSLETTER to receive tips and updates related to business and taxes.


  1. karen rittenhouse

    Hi Brandon:
    I have written much about this as so many real estate investors “assume” their tax preparer understands the laws. Most don’t.

    One problem is that the laws pertaining to real estate investor status are numerous and complex. This requires IRS examiners to use their “professional judgment” when reviewing tax returns to determine the validity of information reported. The fact that it boils down to the examiners personal opinion emphasizes the need for good records and unquestionable time spent in the business.

    A question I get a lot is can husband and wife combine hours. No. The 750 hours et.al. must be met by one or the other. (Both, of course, works too.)

    Here’s a great site:

  2. Bryan Otteson

    Ouch. That’s painful. I was just talking to my wife about getting her RE Agent license and then we could pass through those losses. She would manage our local rentals and maybe do a deal or two. Sounds like with that being her primary job she would still not qualify because she doesn’t spend the hours. Poo.

  3. Dan Heuschele

    I think it is wrong that hours spent researching properties to purchase do not count. If I am an officer in a company researcher acquisitions I get paid for those hours.

    I spend a large amount of hours researching and looking at potential investment properties. Without this effort I would not own the properties to have the income. I then manage those properties but I could not grow the business without additional purchases. I must research to make additional purchases.

    Note I am not indicating that the op is wrong but that I do not agree with the ruling.

    • Brandon Hall

      Hey Dan, I’m wondering if you could justify the research hours via a facts and circumstances test. Past court case rulings, including this one, have indicated that research is considered an “investor” activity because it is not an activity involving in the operation of the current rental business. But if you were doing this full time and could somehow show that research hours are indeed a part of the operations, you may have a chance of justifying it.

      • Bill Gulley

        Great Blog!
        Here’s an idea for you. If you were to provide an escalation clause or rent cap guarantee that your rentals would never exceed a margin over similar units, adjustment made at the termination of the lease, then you would have to pull comps to find the fair market rents in order to meet your contractual obligations in the operation.
        Would adjustments have to be made with a margin that was favorable to the owner? Yes, if it ever exceeded the ceiling, I’d say. It’s where you set your margin, it might be unlikely an adjustment would be needed.
        But, the point is from a marketing perspective in the operations that your rentals offered some rent protection for tenants while the competitors did not.
        Then it becomes necessary to evaluate the market as an operational requirement.
        Could you use the data for any other purpose after your market analysis? Why not? 🙂

    • Brandon Hall

      Thanks for reading Laura, I’d suggest you find a good CPA as they will be an important part of your team by helping you grow and saving you money.

      Research is considered an “investor” activity because it is not an activity involving in the operation of the current rental business.

  4. Jess Aranda

    I absolutely disagree with this ruling. But who are we to contradict the BIG guys ruling. All we can do is follow. I spend a lot of time researching potential properties, making offers, bidding and such to grow my business. So I do delegate some of my duties as an investor to a property manager so I can focus on expanding my business. Although I do post it on rental property websites, and make repair decisions, and tenant application approvals, I still wont meet the 750 hour per year if the research and acquisition part is not included. This is a very helpful article for me I’m glad I had the chance to read it, I have been filing my own taxes and won make this mistake. Im on my third rental, slowly expanding but hopefully will get to the point I can run the business and support my family at the same time. GREAT BLOG!!! a must read for all investors out there.

  5. Jon Tudor

    Thanks for the post Brandon. This is something I’ve looked into intently as my wife and I start our buy-and-hold real estate business. She is currently working to get her real estate license and part of the reason is for the tax benefits.

    I think there is an additional piece of information that needs to be added to this discussion. From my understanding there are two ways that you can reduce earned income with passive rental losses. The first is as you stated in the article, if you are a real estate agent, over half of your activities are related to real estate and you materially participated then you can deduct passive losses in your rental from your earned income. The other way if if your combined (maried couple) MAGI (Modified Adjusted Gross Income) is less than $100,000 you may deduct $25,000 in rental losses from earned income. For every $2 above $100,000 MAGI, $1 is removed from the allowed deduction until $150,000 MAGI is reached.

    In the case in the blog post, it seems that the couple was able to legally count some of their losses, $15,684 (($131,368 – $100,000) / 2 = $15,684) against earned income but too more than this amount when they took $30,146 in rental income losses against earned income.

    I think this is an important point for young investors like my wife and I who make less than $150,000 MAGI. Of course, some day I hope we will make more than that but hopefully when we do my wife will be working in real estate full time and we can meet the method you spoke about in this article.

    Here are a couple of resources I found really helpful on the subject.

    Please feel free to correct me if I’m wrong. As I said, I’m a new investor and want to make sure I can get this right and avoid needing to deal with the IRS!

    • Jon Tudor

      Apologies, a quick edit and clarification.

      The couple could only count $9,316 of rental income loss against earned income. The $15,684 should be subtracted from $25,000.

      For this amount of rental losses to be counted against earned income only active participation needs to be proven, meaning that the couple only needed to prove that they owned at least 10% of the interest in the properties and that they actively made management decisions or arranged for others to provide services in a bond fide sense. No hour requirement. Used this IRS publication as reference.



  6. I remember very well when we covered this section in advanced tax in college.

    Specifically, we spoke about what counts as hours towards the required 750. In my opinion, this is a very grey area and requires a lot of “professional judgment” just like Karen mentioned.

    A couple of points that stand out to me….

    Investors love to throw in the word “research” as their hours spent on the business. This is extremely vague and can mean just about anything.
    Assuming research hours; I don’t know that anyone keeps records of how many hours they spend researching anything. Given this fact, the burden of proof is still on the tax payer, therefore some sort of record keeping is required for just about every activity.
    I have read through the treasury regulations, instructions, and IRS publications on what counts towards these hours, and some of the wording can very well be interpreted one way or another.

    The fact that this is subject to interpretation; it doesn’t surprise me that something like this would go to court.

    Too often I find myself reading IRS publications and coming up with multiple conclusions and interpretations based on the text.

    • Brandon Hall

      Hey Luka, thanks for reading and commenting. I’d agree that each ruling will be based on a facts and circumstances test. Unfortunately, we’ve seen time and time again that the IRS throws out hours spent researching or looking for new properties. They basically disregard the “discovery” phase of projects, even though it’s integral to the sustainability of the business as a whole.

      Regardless, I think in certain cases it could be proven that the research hours are part of the normal operation of the business. But it takes a quality CPA and a solid understanding of the requirements and corresponding risks.

  7. Dane Franta

    A big part that the BP community, including the Podcasts (especially #162 which pretty much only described deductions for RE pros), leave out is the 51% rule. Meaning if you’re transitioning jobs you have to find a way to substantiate that you’ve spent 51%+ of the year performing the duties of a RE pro. This is a big deal in addition to the 750-hour rule. Forbes has a great article with examples (not a short read) that really steps through the qualifying factors a little more in-depth than this as RE pros come from many walks of life. The Forbes article does a good job explaining the grouping of assets as well, an important step for those with multiple properties. Also, the RE pro title brings with it the change from passive to non-passive losses, which is a significant term when understanding how to survive an audit. Bottom line I learned, if you can afford to have a RE pro rather than another W-2 earner and you have items to itemize on your property, qualifying as a RE pro can be a significant shield from the tax community. Just be careful.

    Forbes article, 2014.

  8. Scott Schultz

    I am confused now, I am a Broker that currently buys and holds and I flip, I have been told by several CPA’s I should dump my license (including Tom Wheelwrights firm ProVision) because I dont want to be considered a Professional, maybe because im profitable, but this article goes against what I have been advised, maybe my situation is different. Clarification would be appreciated.

    • Brandon Hall

      I honestly won’t be able to give you solid advice via a comment. But having a license will not qualify or disqualify you from meeting the IRS classification of a real estate professional.

      Perhaps they meant they want to avoid dealer status? Honestly hard to say. Feel free to contact me offline.

    • Dane Franta

      To expand on Brandon Hall’s comment. A license does not a “RE Pro” make. If you spend 51% of your employed hours on RE, which must be at a minimum 750-hours per year, then you’re a professional. A person can be a RE Pro without a license.

      Think about it this way. Landlords and Property Managers do not need to be licensed agents to be RE pros. Brandon admits often on podcasts that he does not have his license, but I’ll wager he is a RE pro on his taxes, solely based on the conversation during podcast #162. Landlords and PMs have the ability, not requirement, to tap into tax advantages because of Adjust Gross Income (AGI) restrictions the IRS has placed for passive losses. Finally, ability to deduct also does not necessitate taking the deductions and itemizing. It’s a case-by-case basis that must consider all tax implications effecting your return.

      Frankly, it sounds to me like any of these are happening or need to happen:
      1) You should get your CPA to clarify their earlier statements, because what they’ve said thus far is confusing
      2) You have a full-time job (51%) that isn’t RE-related in addition to your Broker job and therefore disqualifies you as a RE pro anyway and that’s why they’re telling you to dump the license as unnecessary
      3) You could potentially “save” on taxes by being able to itemize RE agent commissions on your transactions, which is a challenge to figure out and I would leave to CPAs,
      4) You don’t need the commission and maintaining a license is a headache and/or
      5) It would be beneficial find a new CPA who specializes in RE and interview them thoroughly before establishing a client relationship.

      My inputs for what they’re worth.

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