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Are You A “Professional”?

There are many different types of professionals; professional hit men, professional dancers and professional sports figures.  However, there is a type of professional that can be difficult to qualify for but the tax benefits can be very advantageous.

If you own rental real estate and meet specific requirements, you may be considered a “real estate professional.”

The definition of a “real estate professional” for tax purposes is different from the standard definition of this term. For tax purposes, it’s a term used to define an individual who has rental properties and qualifies to treat them as a non-passive activity.

There are several requirements to be considered real estate professional.  The tax law can be a bit complex.  So, if you think you qualify based on the information below, I STRONGLY recommend you have a chat with your tax advisor.

1.       First, you must materially participate in a rental real estate business. Material participation, for IRS purposes, consists of seven different, specific tests only one of which need be met.  These test involve:

  • Participating in the activity for more than 500 hours in the tax year
  • Participating in the activity if the individual’s participation is substantially all of the participation in that activity by any individuals (including non-owners such as a maintenance person or even your attorney);
  • Participating in the activity for more than 100 hours in the tax year, if nobody else (including non-owners) participating more;
  • Participating significantly in the activity, if participation in all “significant participation” activities for the tax year exceeds 500 hours (but this test isn’t accepted for showing participation in rental activities);
  • Having materially participated in the activity during any five of the ten tax years before the year at issue;
  • With respect to personal service activities, having materially participated in the activity for any three years (not necessarily consecutive) before the year at issue;
  • Showing regular, continuous and substantial participation on the basis of all the relevant facts and circumstances, but only if more than 100 hours of participation during the tax year can be shown (and management services aren’t taken into account for purposes of this test unless certain stringent requirements are satisfied). The IRS scrutinizes individuals who claim to meet only this test. We would not recommend using this test as a basis for meeting material participation.

Some typical methods of documenting your material participation consist of contemporaneously kept appointment books, calendars, daily time reports, logs, or similar documents that provide a detailed account of what you did with respect to the activity, when you did it, and how much time it took.

2.       The second requirement is in meeting the more than 50% of the personal services performed by the individual in all trades or businesses are in real property trades or businesses in which you materially participate during the tax year. If you have a full-time job (i.e. 2080 hours a year) in a non-real property business, to qualify for the 50% test, you must claim to work an additional 2081 hours in real property business! This, as you can probably imagine, is very hard to substantiate; therefore, we would not recommend claiming yourself as a real estate professional if this is your fact pattern.

3.       For the last requirement, the individual needs to perform more than 750 hours of service during the tax year in real property trades or businesses in which the individual material participates.

When determining whether you qualify as a real estate professional, only real property trades or businesses in which your materially participate are counted for purposes of the 50% and 750 hour tests.

Once it is determined that you qualify as a real estate professional, the non-passive treatment is available only for rental real estate activities in which the real estate professional materially participates.

These tests are applied annually. This means that you may qualify as a real estate professional in some years but not in other years. As a result, the same real estate activity may generate passive losses in some years and non-passive losses in other years.

If you own and are involved in rental real estate properties, you should consult with your tax advisor to see if you qualify for the real estate professional status for tax purposes. The tax savings can be significant. However, the rules are complicated and the details of your specific situation should be reviewed with a qualified tax professional. If we can be of assistance, please do not hesitate to give Anna Coldwell a call at 312.670.7444.

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