One of the most popular questions we get from our clients is: “do I qualify as a real estate professional?”
The real estate professional status allows passive losses to be deductible against your ordinary income on tax returns without limits. Having this status can be extremely helpful in lowering your tax liability.
The two main criteria you must meet to be a real estate professional are as follows:
- More than 50% of the personal services you perform in all businesses during the year MUST be performed in a real estate business you materially participate.
- You must work at least 750 hours in a real estate trade or business
Let’s discuss these in more detail because I’m sure you are reading this asking “how do I meet the 50%?” and “what hours qualify for the 750?”
More than 50% test
The more than 50% test means that more than half of your annual working hours must be in a real estate business. Generally, if you work a full-time job, you won’t qualify as a real estate professional since you would have to work more hours in your real estate business than you do at your job for the year. For example, if you work 1,200 hours at your full-time job that is not related to real estate, then you will need to work at least 1,200 hours in your real estate business to qualify.
The other part of the 50% test is that more than 50% has to be material participation in a real estate business. To materially participate, the taxpayer must pass the 1 of 7 test, but I’m not going to go into too much detail on all of the tests. The most frequently utilized test is that the taxpayer must participate in the activity for more than 500 hours in the tax year. This is an easy test to meet if you also meet the 750-hour requirement and the more than 50% test.
The 750-hour requirement means you must work 750 hours in a real estate business. Hours that do not count towards the 750-hour requirement are investment activities, such as researching new listings. It is extremely important to keep records of your hours if you believe you meet the 750-hours, there must be supporting documentation to prove that you worked those hours.
Another factor that comes into play is that each of your rentals are treated as separate activities, or businesses, unless you make an election to treat all those interests as a single activity. If you do not elect to treat your rentals as a single activity then you will have to work 750 hours on each of the rental properties. So if you qualify for one rental property and you did not make the election, you would not qualify for the other properties. However, if you do make the election, you only have to establish material participation, and satisfy the more than 50% test and the 750-hours test, for the combined properties as a whole.
Make sure you keep a log of your real estate hours for each property and for personal if you work full time. Consider making the election to treat all properties as a single activity so you do not have to meet the qualifications for each property. If you are still unsure if you qualify, talk with your CPA.