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Real Estate Professional Status (REPS) is enticing to real estate investors for a few reasons, not least of which is the tax benefits.
But what does it take to gain real estate professional status? Is working toward qualifying worth it in the end? How many hours will I have to put in to gain REPS? What kind of activities count toward these hours?
Read on to get answers to all these questions and more, and don’t miss our 12,000 word guide covering all the ins and outs of qualifying as a Real Estate Professional. Want to discuss with an expert? Reach out to Hall CPA to start your journey to REPS.
Real Estate Professional Status: An Overview
Real Estate Professional Status, or REPS, is a tax designation allowing those who manage their rental real estate holdings to have the income and losses from these activities treated as non-passive.
The IRS considers income from real estate investments passive by default, meaning the losses your portfolio produces due to depreciation can only be deducted against other passive income - for example, rental income you receive from tenants.
To be able to deduct your real estate losses from non-passive income (typically a W-2 job or income from a business you own), you need to have your real estate investing activities characterized as non-passive. REPS offers you a path to achieve this characterization.
So you want these tax benefits - but are you a good fit?
If you actively manage your rental real estate portfolio and work in real property trades or businesses you own as a your primary occupation, you might be. Securing REPS means the income and losses from the properties are treated as non-passive, enabling any losses from your rental real estate properties to be deducted against other non-passive sources of income - which has the potential to save you thousands of dollars in taxes.
Real Estate Professional Status: How Many Hours Do I Need?
Before we dive into the annual hours necessary for REPS, let’s discuss the tests the IRS requires for qualification.
1. 50% Test
The first test requires that real estate professionals work over half of their annual working time in a “real property trade or business.”
There are eleven permitted real property trades and businesses: real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade. If you participate in more than one of these activities, you may be able to combine your hours to count toward the total.
2. 750 Hours Test
In addition to meeting the 50% test requirement, real estate professionals must spend more than 750 personal service hours materially participating in one of the real property trades or businesses mentioned above.
Personal service hours are hours spent managing the operations of your real estate business. However, not every hour you actually spend on your real estate business counts toward the tests––only the hours that are material to your business. We will discuss material participation shortly.
If you have a full-time job outside of your real estate business or actively run your own non-real estate business, it is nearly impossible to meet these requirements. If you work part-time, the right approach and the support of a well-established real estate accounting firm could make it work. It’s worth bearing in mind that Real Estate Professional Status is primarily designed for, well, professionals who manage their own rental portfolio and work in real estate as their primary occupation.
To sum up, investors need to spend over 50% of all their annual personal service (work) hours in a year AND 750 hours materially participating in real property trades or businesses, including their rental activities to qualify.
What Does Material Participation Mean for Real Estate Professional Status?
The short answer: you need to be actively involved in the upkeep and activities of your rental properties.
The longer answer: material participation is an important but complex test you must satisfy to earn REPS. Satisfying the requirement of material participation requires real estate investors to meet one of the seven criteria the IRS outlines. Many real estate professionals that we work with qualify via the first test; participating in the activity for over 500 hours. We encourage you to reach out to a tax professional for guidance around whether you materially participate in your real estate activity.
What Activities Count Towards Hours for Real Estate Professional Status?
Material participation hours include time spent on the following activities:
- Working on repairs or construction at the property
- Hiring and managing a general contractor or handyman for the property
- Communicating with tenants
- Acquisition of a property, e.g. time spent searching for a property you do purchase
- Most activities that a property management company would handle
Activities that do not count as material participation are things like:
- Real estate education
- Investor hours
- Unsuccessful acquisition, e.g. time spent searching for a property you do not purchase
- On-call hours where no work is actually performed
The IRS does not specifically outline these requirements. Your best plan of action is to diligently keep time logs and records backed by proof such as emails and calendar appointments. It’s always best to work with a professional to ensure you are meeting the hours threshold.
Record Your Hours for Real Estate Professional Status
Just putting in material participation hours is not enough: you also have to provide proof. Being taxed as a real estate professional increases your chances of an audit, and the burden of proof is on you, not the IRS. In this case, having strong documentation of the time you spent managing your properties significantly improves the likelihood of a positive outcome.
Real estate professionals should maintain time logs on a contemporaneous basis. Simple diary entries are generally not enough - you need to be able to provide actual proof.
What qualifies as proof? Many things, such as emails, calendar appointments, meeting minutes, receipts, and more. Keep records of anything you believe could be relevant.
Partner with a Specialized Real Estate Tax Advisor
Don’t let this information overwhelm you or dissuade you from seeking your Real Estate Professional Status.
If you believe you’re a good fit for the REPS designation and want to ensure you are on the right track, speak to a specialized real estate tax advisor. Even if you don’t meet the criteria for REPS right now, a good tax professional can help you map a plan to get there, plus there are many other real estate tax strategies you could take advantage of. Whatever the case, it is important to seek guidance from experienced real estate tax professionals.
At Hall CPA, we specialize in real estate tax strategy and have extensive experience in guiding investors through the complex process of qualifying as a real estate professional. Contact us today to get started.