What Is Real Estate Professional Status?
The IRS considers you a real estate professional if you manage rental properties, invest in real estate, and make meaningful contributions to your real estate business.
You must work in the real estate industry for more extended periods than any other career or job you have taken to get the title of a real estate professional.
You can only qualify for a real estate professional certification after devoting at least 50% of your time to the real estate industry. In addition, you cannot claim this status while working a full-time job. Although you are permitted to work a part-time job, you must demonstrate through an audit that more than 50% of your time was spent meaningfully advancing your real estate firm.
What Are the Benefits of Real Estate Professional Status?
Let’s look at an instance to fully demonstrate real estate professionals’ advantages. Suppose you have a spouse and a doctoral salary of $250,000. Your spouse is a homemaker and accepts the primary management role for your rental income properties. You lose $150,000 off your real estate business the year your spouse works in the real estate industry.
According to the free online calculator provided by SmartAsset, if your spouse does not declare real estate professional status, you are taxed on the entire $250,000. As a result, you will owe $54,369 in federal income taxes in 2019.
You can deduct the entire $150,000 from your $250,000 clinical income if your spouse qualifies as a real estate professional. When you pay tax on $100,000, your whole tax obligation is reduced to $16,279.
You enter a reduced tax band and a significant decrease in your taxable income. As a result, your taxable income decreases from $250,000 to $100,000.
In the situation where your spouse does not maintain real estate professional status, what happens to the $150,000 in real estate rental loss?
Due to your income level, you cannot utilize any of these losses. If you are filing jointly and earn more than $150,000, please refer to IRS Publication 925. There are no “special allowances” in this case. You carry these forward until you make silent gains from the rental properties or sell the property; they are referred to as “passive suspended losses.” As a result, you lose out on all tax advantages.
How to Qualify as a Real Estate Professional for Tax Purposes
You must fulfill the IRS standards and keep records to support your requirements to be recognized as a real estate agent for tax purposes. The qualifications needed to be designated as a real estate professional are outlined in detail by the IRS.
However, you must fulfill the following requirements to be considered as a real estate agent for tax purposes:
At Least 750 Working Hours in the Real Estate Industry
To qualify for real estate professional status, you must manage your rental portfolio for at least 750 hours during the tax year. Only real estate-related work is permitted during these hours.
Activities that qualify toward the 750-hour requirement include managing repairs or renovations to a property, physically participating in construction projects, marketing a property, and advertising and leasing your rentals. Researching listings and other investment-related activities don’t count.
Additionally, for every rental property you declare, a real estate professional must have an ownership stake of at least 5%.
More Than 50% Material Participation in the Real Estate Industry
To be considered a real estate professional, you should materially participate in real estate investments. Therefore, more than half of your yearly working hours must be dedicated to the real estate trade or firm in which you have a material interest. As a result, if you work full-time, you cannot be eligible.
Involvement in tasks like active property management, acquisition, construction, reconstruction, or brokerage trade earns one material participation. You are required to carry out these duties consistently, frequently, and significantly. The IRS uses the 500-hour cutoff to evaluate significant involvement.
As previously stated, the 750-working-hour threshold does not include time spent on investment-related activities. However, if you are actively involved in the day-to-day management of the portfolio, you can use them to pass the Material Participation Test.
Note: It’s essential to keep in mind that only individuals, not businesses, are covered by the tax status for real estate agents. Your rental portfolio hours cannot be combined with your spouse’s to reach the 750-hour minimum requirement. One of you must independently pass both tests.
When Should You Become a Real Estate Professional?
Real estate professionals undoubtedly benefit significantly from tax benefits. However, this does not mean everybody can submit an IRS status application for a tax benefit. Before applying for this status, you need to take into account the following factors:
You Own Rental Real Estate
Tax benefits for a real estate investment are provided by having the status of a real estate professional, especially if you have a sizable rental portfolio. You can qualify for significant tax benefits if you work in real estate and own many rental properties.
The real estate professional credential can be used to offset a sizable amount of your income, even if not all of it. For example, your efforts could be rendered useless if you only have one rental property. However, one rental property might not generate enough losses to qualify as a real estate professional.
You Don’t Have a Full-Time Job
If you don’t have another full-time job, you’ll find it easier to adhere to the real estate professional qualification standards. Whatever personal services you offer in the real estate industry shall be your exclusive personal services.
As a result, you’ll find it simpler to fulfill the 750-hour criteria. The IRS takes this designation seriously, and individuals who don’t seem likely to succeed will have their accounts audited.
In other words, the IRS will be suspicious if you can devote more than half of your time managing real estate holdings and thereby start earning lots of money as an actively employed professional. The majority of those who work overtime are automatically rejected.
Tips to Qualify as a Real Estate Professional
Although achieving Real Estate Professional status comes with many benefits, it is a challenging title to uphold. Here are some pointers to assist you in becoming a real estate professional.
Increase Your Daily Portfolio Management Responsibilities
Actively manage your real estate holdings on a daily basis. You might soon spend more time on this than is necessary to qualify for the 750-hour IRS requirement.
Part-Time Work
If you work part-time or are willing to do so in the near future, think about how many hours you need to put in and whether you can manage your real estate holdings and real estate investing opportunities properly in more than half of your free time.
Involve Spouse
You can ask your spouse to apply if you already hold a full-time job. But, of course, your partner should complete the task at hand, not just make a promise. So make sure that your spouse agrees with this strategy and is ready and willing to take on this time-consuming duty after carefully reading the IRS standards.
Keep Detailed Records
Due to the substantial tax advantages, the IRS wants to ensure you meet all stated requirements of a real estate professional. Therefore, they will regularly inspect your real estate records to enforce the law.
To pass this inspection test smoothly, you must maintain an account of your working hours. To do this, you will need to provide supporting documentation which proves that you put in 750 hours of effort and fulfilled the higher-than-50-percentage-point requirement. This is done by maintaining thorough records of your activities and time spent working in real estate. This is very important for a real estate investor involved in industries other than real estate.
Real estate professionals are eligible for various tax advantages if they satisfy the IRS’s requirements. Consider obtaining your real estate professional status to benefit from all of the possible real estate agent tax deductions if you’re considering learning how to be a real estate investor and want to optimize your revenue. Make sure you deal with a certified and knowledgeable tax professional to get off to the best possible start when using this tax strategy.
