Brian Borawski CPA, PC

Archive for the ‘Real Estate Professional’ Category

Alright, over the last few weeks I’ve gone through the requirements you have to meet in order to deduct real estate losses as a real estate professional.  If you didn’t catch them, I did it in three parts and you can click through from here.

Real Estate Professional Rule 1
Real Estate Professional Rule 2
Real Estate Professional Rule 3

Now we’re going to talk about some planning ideas.  This is going to be a living post in that whenever I have a thought or learn something new on being a real estate professional, I’m going to add it here.  As always, I’m going to keep things general and you should always consult with your tax adviser before you implement any of these ideas.

1)  We’ve talked about how it can be tough meeting the 50% rule if you have a full time job.  That means if you work full time, you have to come up with at least 2,000 in your real estate business.  That doesn’t leave a lot of time for sleep.  One was to meet the requirements is if you have a spouse who’s either been out of work or is a stay at home parent.  If they’re not involved in the business and you find yourself not being able to take your losses because of the passive activity rules then it’s time to get them involved.  They still have to meet all three rules though.  One spouse can’t meet one rule and the other spouse two rules, in order to qualify one spouse has to meet all of the three rules.

Fortunately, while being a full time parent is as hard as any job, it doesn’t qualify as a business so most of the time, if the spouse can meet the 750 rules, then they’ll meet the other two rules as well.  So get your husband or wife involved and that can help you deduct those losses.

2)  Remember about the grouping election.  If you don’t elect to group your real estate activities, then you have to meet the active participation for each one individually which can get challenging as your real estate portfolio grows.

3)  Short term rentals don’t apply. If you have a vacation rental where the average lease term is seven days or less, then the hours devoted to that activity don’t qualify.

Alright, we’ve talked about what you need to do to qualify as a real estate professional for tax purposes.  Rule one was the 750 hour rule.  Rule two was the material participation rule.  The final rule that we’ll be talking about today is what I call the 50% rule and for a lot of people, it’s the one that trips up most people and disqualifies them from being a real estate professional.  How the 50% rule works is, you have to spend more then 50% of the time you spend on personal services for the year in real estate and rental real estate trade or business activities.

Where most people run into problems is when they have a full time job.  If you spend 2,000 hours at your job, you then have to spend 2,001 hours on real estate to qualify as a real estate professional.  That doesn’t leave people too much time to sleep.  And these people (those who get a W-2 and then claim to be a real estate professional) are some of the people the IRS is targeting.  So look at the 750 hour as the minimum but what you really need to get to is a match of time you put into your other businesses or jobs.

I’ll have one more post on the real estate professional status before I move on to something else.  It’ll be mostly some planning ideas.

A couple of weeks ago, I touched on qualifying as a real estate professional and I talked about the 750 hour test.  Rule two is that the 750 hour test has to apply to activities in which the person materially participates.  The catch here is you have to look at each activity individually (sort of, I’ll get to the exception in a minute).

In order to materially participate, you have to meet one of the following requirements:

1)  The taxpayer spends 500 hours on the property.
2)  The taxpayer does most of the work.
3)  The taxpayer works more then 100 hours and nobody else works more hours then he does (this is the one most people shoot for).
4)  The taxpayer has several activities and spend in which he spends 100-500 hours each and the total time spend is 500 hours.
5)  The taxpayer materially participated in an activity for five of the last ten years.

Where you run into the most problems is when you have multiple properties.  Fortunately the IRS lets you make an election to group all of your properties together as one activity.  You have to make a formal election on your tax return though and if you’ve never done this and have put yourself out as a real estate professional, you do have some risk.  The election isn’t all that complicated, but if you’d like a free template, feel free to send me an email or a Facebook message.

Real estate can be a great way to both build wealth and shield the money you make from your investment from taxes.  Of course the down side is, if you have a tax loss from your real estate investment, you can’t always use those losses especially against income you may receive from your job.  You’re even further limited the more money you make and while the passive activity rules are complicated enough and a discussion for another time, one way to ensure your losses are utilized as quickly as possible is to qualify as a real estate professional.  By qualifying as a real estate professional, you can usually take your losses in full and in the year you incur them.  It’s not always easy to qualify, but there’s three rules that have to be met.  As always, this is general information so be sure to talk to your tax adviser so he can opine on your particular situation.  We’ll cover the first one here today and the other two in subsequent columns.

The first rule is that you have to spend 750 hours to rental property activities.  I know I lead up to this and it’s one of the easier rules to understand, but you also have to be careful because in order to qualify as a rental activity, the average rent term has to be longer then a week.  If it’s shorter, then the time doesn’t count.   So if you have a short term rental property like a vacation home where you rent it out for six days and have a cleaning day, then you can’t count your time related to that activity.

Keep your eyes open for rule number two in the next couple of days.

Last month, a pretty important Revenue Procedure came out.  In Rev. Proc. 2011-34, we get some updated guidance on fixing making a late election to aggregate your rental real estate activities when determining whether you qualify as a Real Estate Professional or not.  To qualify, you must meet a three pronged test (I’ll probably dedicate an entire blog post to the rules here but in the meantime, I took part in a conference call on this subject a few months ago that’s worth listening to). One of those tests is that you materially participate in each real estate activity.  By making an election, you can choose to aggregate your activities so all of them are effective used in total to determine whether you meet the test or not.

It’s fairly common to miss the election and the consequences can be severe.  With this Rev. Proc., it’s not a lot easier to make a late election to help cover yourself.