7 Myths About the Real Estate Professional Tax Status, Debunked

10

For investors who are also high income earners, the real estate professional status is undoubtedly one of the most powerful tax tools that can potentially help someone bring their tax bill from 35% down to 15% or lower. A while back, I wrote a blog post about all the wonderful tax benefits of being a real estate professional called “Your Complete Guide to the Real Estate Professional Tax Loophole.”

I received quite a few questions on that topic and also noticed there was a lot of misinformation floating around out there. This week I wanted to talk about 7 common myths regarding the real estate professional status.

How I Bought, Rehabbed, Rented, Refinanced, and Repeated for 14 Rental Properties

This is the dream right? Going from zero to 10+ rental properties, providing stable cash flow and long-term wealth for you and your family, and building a scalable business model to boot! Learn how this investor did just that, in this exclusive story featured on BiggerPockets!

Click Here For Your Free eBook

7 Myths About the Real Estate Professional Tax Status, Debunked

Myth #1: Being a real estate professional is important for everyone involved in real estate.

No, this is incorrect. The real estate professional status is only important to people who own rental properties. So if your real estate activities only consist of flipping real estate or wholesaling real estate, then you do not need to worry about being a real estate professional, as any net losses can generally be used to offset other income without limitations. This means that you do not need to prove you spend a certain number of hours in your flipping activities as you would otherwise need to if you were a landlord.

Myth #2: If I own rentals, I will always benefit from being a real estate professional.

This is also incorrect. If you own rental properties, this does not necessarily mean that you need to qualify as a real estate professional in order to get your deductions. In fact, whether you qualify as a real estate professional or not, you can always use your expenses and depreciation to offset rental income. Being a real estate professional is only important if you have a net loss on your rental properties, which are limited as a result of higher income for a particular year.

tax-extenders-2015

Related: Tax-Saving Strategies for Real Estate Investors: How to Pay Less & Keep More This Year

Myth #3: LLCs can be real estate professionals.

From time to time, I come across investors who have been told that using an LLC can help them become a real estate professional. Unfortunately, this is incorrect, as real estate professional status is only determined by the person involved in the real estate. For example, if you work 2,000 hours a year at your job and you have an LLC that is formed to only hold your rental properties, you still need to show that you personally spent more than 2,000 hours per year on rental activities. The fact that all your LLC does is rental activities does not help you to personally become a real estate professional. Having an LLC is a good idea for asset protection purposes, but keep in mind it does not help you get around the hours requirement for being a real estate professional.

In short, LLCs and other types of legal entities cannot be real estate professionals; only you as the individual investor can attempt to qualify for that designation.

Myth #4: If I get my license in real estate, I become a real estate professional.

This is also a common misconception that I hear from time to time. Since real estate professional status is only a rule in the tax world, it really does not matter what licenses you hold with the state. Let’s look at two examples to illustrate this point. Jamie is a long time real estate investor. She owns close to a dozen properties and manages most of them herself. Jamie retired from her full time job as a teacher many years ago and now spends most of her time on her rental properties. Although Jamie never obtained her license to be a real estate agent or real estate broker, Jamie was able to qualify as real estate professional because she spent more than 750 hours in real estate and she spent more time in real estate as compared to her job. For Jamie, it was easy for her to qualify that she spent more time in real estate as compared to her job because she simply did not have another job.

Let’s go over a difference scenario.

Becky wanted to get into the real estate business. She owns one rental out of town that is managed by a property manager. Becky has been very fortunate in that her property is fairly hassle-free and she is able to spend very little time on it. Becky decided to become a real estate agent and spent some time to obtain her license. After obtaining her real estate agent license, Becky got employed by a broker as a full-time employee. Becky spends most of her time working as an employee for this broker. In this scenario, although Becky obtained her real estate agent license, it does not automatically mean Becky is a real estate professional. Since Becky has a W-2 job, Becky must be able to show that she spends more than 750 hours materially participating in her out of town rental and that she spends more time on her own rental than her W-2 job. As such, if Becky works 2,100 hours at her full time job, then she must be able to prove that she spent more than 2,100 hours on her rental property in order to qualify as a real estate professional.

Now here is a little twist. In the same example above, if Becky was hired by the broker as a 1099 contractor instead of a W-2 employee, then it may be easier for her to qualify as real estate professional. For those of you who are both real estate agents and investors, make sure to strategize with your tax advisor on which route makes the most sense for you in terms of tax savings.

Myth #5: I must be a real estate professional each and every year.

Contrary to popular belief, real estate professional status is not a one-time test and is actually a year by year designation. It is possible (and common) for investors to claim real estate professional in one year and not the next.

Take the example of Mary. Mary was a full-time nurse and part-time real estate investor. She decided to take a few years off from her nursing career to stay at home and take care of her elderly mother. During those years, she spent a lot of time on her rental properties and was able to claim real estate professional status. A few years later, Mary went back to work full-time as a nurse after her mother’s health recovered. After going back to work, Mary was no longer able to show that she spent more time in real estate as compared to her job, so she stopped claiming real estate professional status.

house-hacking-tax

Related: 4 Bookkeeping Best Practices to Save on Taxes (& Survive Audits!)

Myth #6: To claim this designation, I simply list my occupation on the tax return as real estate professional.

For those of you claiming real estate professional, it is important to make sure that you list your occupation on the tax return to be as such. I often see investors claim to be real estate professionals on their taxes while indicating on the tax return that they occupation is something different. Although labeling your occupation as real estate professional can help to minimize audit risk, there are more actions that need to be taken on the actual return to document this designation.

For those of you who own multiple rental properties, it is important to make an election to aggregate your rental real estate as one activity. By doing so, you are telling the IRS that instead of spending 750 hours of material participation on each of your rentals, you are combining them into one single activity so that the 750-hour threshold is only required for all your rentals as one unit. Unfortunately, the election is not a simple box to check on the tax return nor a specific form to be filled out. It is a separate election language that is attached to your tax return. An example of this should read:

“Jane Smith hereby elects to combine all rental real estate interests into one activity pursuant to Code Sec. 469(c)(7)(A) and Reg. §1.469-9(g)(1).”

Myth #7: I must be a real estate professional in order to take a home office.

This is another common but incorrect assumption. One important thing to note is that regardless of real estate professional status, business expenses that are ordinary and necessary for your real estate business are generally tax deductible items. In the example of a home office, as long as you have a qualified home office, it is possible to claim the home office deduction each year regardless of whether you are a real estate professional or not.

Check out my article on “3 Reasons You Should Love the Home Office Tax Deduction.”

The same goes for travel costs, real estate education, computer expenses, and so on. Make sure you claim all your legitimate real estate-related expenses. Even if an expense is limited in a particular year due to higher income thresholds, those expenses can generally be carried forward into future years to offset future taxable income.

For more information on entities and tax strategies, check out Amanda’s book The Book on Tax Strategies for the Savvy Real Estate Investor.

Investors: Have any questions about the real estate professional status? Any myths you’d add to this list?

Leave your comments below!

About Author

Amanda Han

Amanda Han of Keystone CPA is a tax strategist who specializes in creating cutting-edge tax saving strategies for real estate investors. As real estate investors herself, Amanda has an in-depth understanding of the various aspects of investing including taxation, self-directed investing, entity structuring, and money-raising.

10 Comments

  1. Kimberly H.

    Great article!

    I was told something by an accountant claiming to specialize in RE accounting a few year ago…he said for a person to use Real Estate Professional status on their return, that if the rental properties are owned in LLCs, that the person claiming the RE Professional status must be the sole owner of the LLCs. As opposed to them being jointly owned between them and their spouse. Do you agree? Disagree? Interestingly enough this accountant who told us all about this actually forgot to use this status on the 2012 return they prepared, which was only recently discovered…is it to late to amend it?

    Or did they not forget and have a reason… is there any reason that a person who meets the RE Pro Status requirements would NOT want to claim RE Pro status on a return? Any case where claiming it could result in them paying MORE in taxes?

    • Amanda Han

      Thanks Kim! I do not agree with that assumption as real estate professional is with respect to a person and not an entity. The fact that an entity is owned by that person or multiple people should have on impact. The 2012 year has closed, so unfortunately you would not be able to amend for that year.

  2. Huiping Sheng

    Amanda,

    I am a new agent but full-time employee other than RE.

    Can I deduct the fee to join local REIA, MLS, or PRO fee of BP?

    If my 2016 income from REI is lower than my expenditure of those fee I spend on RE, can I deduct those spend from my W-2 income or only from RE related income? Can I can carry those spend for 2017 tax deduction?

    Thanks for valuable teaching.

    Huiping

    • Amanda Han

      If they are rental real estate related you can likely deduct the RE club fees as education expenses. Losses that you cannot take in 2016 will carry forward as suspended losses until they can be used or the property is sold. If your income is lower than $150k then you may be able to take a portion of the real estate losses to offset your W-2 income. If not, then you cannot take the losses unless you have other passive income or if you qualify as a Real Estate professional. Alternatively, if you are in the business of being a realtor and you have started that business then yes you can potentially deduct those expenses in the year you incur them regardless of income level. Along those same lines, any net loss from realtor activities should be available to offset W-2 income.

  3. Huiping Sheng

    Thanks Amanda!

    You said ‘ If your income is lower than $150k then you may be able to take a portion of the real estate losses to offset your W-2 income’.
    Could you please give a help for this restriction of <$150k on a married status, or what is this restriction for my husband and me?

    Mostly my 2016 REI income will lower than my w-2 income. If my REI income is lower than my non-REI W-2 income, can I deduct my education cost of REI from my non- REI W-2 income?

    Really appreciate your very kind sharing!

  4. Huiping Sheng

    One more question really wants to get a help from you:

    Based on my non-REI status, I will not qualified as a RE professional because I am full-time on non-RE field. As a new REI, my passive income in 2016 will lower than my W-2 income,

    1) can my education, expenditure, such as drive around to check the properties, be deducted from my W-2 income?

    2) If I have some remodeling work for a rental house, and the rent income is not enough to cover my remodeling expenditure during 2016, can I deduct the remodeling cost from my family w-2?

    Thank you so much Amanda!

Leave A Reply

Pair a profile with your post!

Create a Free Account

Or,


Log In Here

css.php