If you own several properties, you may want to check with your CPA to see if you qualify – in the eyes of the Internal Revenue Service (IRS) – to be classified as a real estate professional. The IRS has a special provision with specific criteria to determine if you qualify as a real estate professional. If you qualify, there is a set of tax rules which are designed to provide certain benefits and deductions to individuals who are actively engaged in real estate activities as their primary occupation.
As a real estate professional, you will qualify for some exceptions in the tax code. These exceptions are:
The Special $25,000 Allowance Limitation does not apply, which means you can have more than $25,000 of active real estate losses.
The $100,000 Modified Adjusted Gross Income test does not apply.
The $100,000 to $150,000 phase-out rules do not apply.
The basic criteria to determine if you qualify are as follows:
Material participation: To qualify as a real estate professional, you must meet the IRS’s criteria for material participation. This generally means that you must be involved in the real estate trade or business on a regular, continuous, and substantial basis. The IRS has specific tests to determine material participation, such as spending at least 750 hours per year in real estate activities and performing more than half of your total working hours in real estate activities.
Active participation: If you don’t meet the material participation requirements, you can still potentially qualify for certain deductions if you actively participate in rental real estate activities. Active participation involves having a significant role in management decisions, such as approving tenants, setting rental terms, or making repairs.
If you qualify, the following benefits might be available to you:
Deductible expenses: Real estate professionals can deduct various business-related expenses, including advertising costs, property management fees, repairs and maintenance, insurance premiums, professional fees (e.g., legal and accounting services), travel expenses for business purposes, and mortgage interest. These deductions can help reduce taxable income and lower the overall tax liability.
Losses and passive activity rules: Real estate professionals may be able to offset losses from their real estate activities against other types of income, such as wages or investments. However, these losses are subject to the passive activity loss rules, which limit the deductibility of losses from passive activities (those in which you do not materially participate).
As always, consult your CPA, or professional tax advisor to see how these rules might affect your specific situation.
By Duane Duggan. Duane graduated with a business degree and a major in real estate from the University of Colorado in 1978. He has been a Realtor® in Boulder since that time. He joined RE/MAX of Boulder in 1982 and has facilitated over 2,500 transactions over his career, the vast majority from repeat and referred clients. He has been awarded two of the highest honors bestowed by RE/MAX International: The Lifetime Achievement Award and the Circle of Legends Award. Living the life of a Realtor and being immersed in real estate led to the inception of his book, Realtor for Life. For questions, e-mail [email protected], call 303.441.5611 or visit boulderco.com.