Real Estate Professional Status 101: The Top Tax Strategy

For full REPS rules, see guide.

Historically, high earners (like doctors and lawyers) would use real estate losses to offset their hefty W-2 or business income. But the Tax Reform Act of 1986 reclassified rental activity as “passive,” preventing most people from using rental losses to reduce active income.

REPS was introduced to allow certain investors to overcome these passive-loss limitations. If you qualify, rental losses can become non-passive, meaning they can offset W-2 or other active income.

This often slashes investors’ overall tax bills by five or six figures.

Transcript

Introduction

Thomas Castelli, CPA (00:01.045)
Welcome back to the Tax Smart REI Podcast. In today’s episode, we’re going to be talking about the real estate professional status, also known as REPS, and how you can use it to save substantial amounts of money on your taxes. If you’re able to, or your spouse is able to, work full time in real estate, it’s probably one of the most powerful tax strategies next to the short-term rental loophole.

We’ll be diving into all that in just one minute.

Quick Update: Corporate Transparency Act

Thomas Castelli, CPA
All right. So before we dive right into the real estate professional status, I wanted to make one quick update. And this is the last update I’m going to make unless something is permanent with this.

The Corporate Transparency Act of 2024 (CTA) is now back in effect. If you remember on our last episode, I believe it was, I mentioned briefly that it was suspended. There was a stay, or it was paused essentially by a court in Texas, and between… oh, and over the holidays, it is now put back into place, and the due date now is January 13th.

So this episode is gonna be coming out on the 7th of January. That gives you about six days to go ahead and comply with it. My two cents on it right now is just go and comply with it, period, end of story. It looks like it’s going to be here. It got reversed twice or got stayed twice, and now we’re back here again. So that’s the last thing I’ll say on it.

Setting the Stage for Real Estate Professional Status

Thomas Castelli, CPA
But last week on our last episode, we went through the short-term rental loophole and how you can save up to five or six figures when you invest in short-term rental properties. And that’s great if you work part-time; it’s great if you love the short-term rental market.

But what if you own long-term rental property, right? How can you use long-term rentals to reduce your taxes? And that’s what we’re going to be talking about today with real estate professional status.

Background: REPS vs. Short-Term Rental Loophole

Ryan Carriere, CPA (01:57.772)
Yeah. And like Tom mentioned, just to say it again, the short-term rental loophole is for short-term rentals, right? It’s in the name. I like to reference that when I talk to people, just to make it seem as obvious as possible. And then real estate professional status is for long-term rentals.

For maybe some context as we move into discussing this further, this really came out with the Tax Reform Act of 1986. So really before that—and then we’ll probably get into this, we’d like to get into kind of, you know, what does this mean for us in the specifics—but 1986 was a big Tax Reform Act. So before that, we had people like really high-income earners—physicians, high-income attorneys, you know, people like that—who were basically using losses from rental properties and offsetting their physician income, things like that.

And it was kind of like, “Hey, they found through this data, some sort of survey that the IRS did, that these really high-income doctors are effectively paying very low tax because of these losses from real estate offsetting their income.” And so basically, they said, “Yeah, we need to change this.” So we got these buckets of passive and non-passive. The big change here for real estate investors was all those losses from rental properties specifically then became by default passive. That was kind of the new part.

Before it was like, everything was kind of non-passive as far as I’m concerned. And now we’ve got this by-default comment that all rental properties were considered passive. And so some time went on, right? And then I think the real estate professional “exception,” if you want to call it that—or strategy—really came out a few years after this Tax Reform Act. And so we’ll start moving into that now.

But really what it’s going to do is move rental properties—again, specifically long-term rentals that were by default passive—and now transition their character to being considered non-passive. And when we’ve done that, now those losses can offset your other non-passive income.

So what is that, for example? W-2. I mentioned a physician, maybe a high-income attorney, you’ve got W-2 income. It could also be that you’re a business owner, you’ve got some business profits (non-passive income), things like that, or portfolio income. So that’s really what it’s doing—just the ability to transition from the passive bucket into the non-passive bucket for those long-term rental losses.

Qualification Requirements for REPS

Thomas Castelli, CPA (04:14.865)
Absolutely. One thing I’ll throw in there before we break down some of the requirements and some of the things you need to qualify for the real estate professional status is that this usually includes “midterm rentals,” right? A lot of people in the short-term rental space sometimes come across the ability to rent their property for 30 to maybe 90 days—traveling nurses, traveling doctors, digital nomads, all that good stuff. There is a market for these midterm rentals.

And it’s important to note that, as far as the tax code is concerned, there’s no such thing as a “midterm rental,” all right? What you have is short-term rentals with an average stay of seven days or less (and we’re not going to 30 days or less if you provide substantial services), or you have a long-term rental property, or you just have a rental property. That’s it. There’s no in-between.

So when we’re talking about the real estate professional status here today, note that that probably means, like, 99% of the time, your “midterm rental” is going to count as a regular rental.

Alright, so how do you qualify as a real estate professional? How do you get these benefits? Well, you need to meet two criteria:

• You need to spend more than 750 hours in a real property trade or business. We’ll talk about what those are in a second.
• This needs to represent more than 50% of your total working time.

Now, I want to point this out because this is an important part: if you are a full-time W-2 employee, the IRS considers you to be working roughly 2,000 to 2,080 hours per year. That means to spend more than 50% of your total working time in a real property trade or business, you need to work 2,001 to 2,081 hours in real estate, which is roughly 81 hours a week for virtually the entire year.

The IRS knows that’s basically not possible for all intents and purposes, and so do the tax courts, and they often agree with the IRS here.

So the way you can get around this is by either using the short-term rental loophole part-time, or by having your spouse qualify, right? If one spouse qualifies, then both spouses get the benefit of the real estate professional status if you’re filing a joint return.

A key thing here: if your spouse is qualifying or you’re qualifying for the real estate professional status, you cannot combine hours for that 750-hour requirement. One spouse needs to meet this by themselves.

So that’s how you qualify for the real estate professional status. Do we wanna go into a little bit about what the real property trades or businesses are and how that all fits in here?

Real Property Trades or Businesses

Ryan Carriere, CPA (06:58.242)

Yeah, so there’s a total of 11 real property trades or businesses. I’ll just briefly list a few of them. The first—I like to break down the 11 into three different categories:

• Development, Construction, Conversion – I picture someone with a hard hat, the physical real estate itself getting built.
• Transactional – Acquisition, brokerage, leasing—think of someone like a realtor buying and selling.
• Management – The rental portion, operations, or property management—overseeing and making decisions, bringing in new tenants.

That’s an oversimplification, but it’s a nice framework. The one common misconception here is that people think, “I’m generally in real estate; I must meet this real property trade or business.” I’ve seen people writing on LinkedIn who aren’t CPAs or EAs or experts in tax, and they’ll say lenders will qualify for real property trade or business. That’s very frustrating. I’ve almost reached out to a couple of them. So you just need to be careful what you’re reading out there. That’s just one example of what would not qualify.

Thomas Castelli, CPA (08:33.821)

Yeah, right, right. Let’s drill down a little because I think there’s some strategy here for people who are listening—how you can actually get involved in different real property trades or businesses. To kick this off: as Ryan said, mortgage brokers and lenders are in the business of lending as far as the IRS and the tax courts are concerned, and they’re not considered a real property trade or business. So let’s just set that aside. There are detailed explanations on why that is, but just know that it’s pretty clear-cut that they don’t count.

So what are some strategies? Sometimes you might be a full-time real estate agent or broker. That makes you a prime candidate for the real estate professional status. If you’re working on a 1099 basis and you’re doing it full-time, you’re likely meeting that 750-hour and more-than-half-your-total-working-time requirement. That’s great. In that case, if you go and acquire rental properties and self-manage them, you’ll be able to take the losses from your rentals and use them to offset your income from your agency or from the commissions you generate as an agent or broker. That’s fantastic.

And for a married couple, one spouse may have a full-time job that’s high-income or a non-real-estate business. If the other spouse can qualify as a real estate professional, then both qualify for the benefit if you file a joint return. So one strategy that people often use is they’ll become a real estate agent in addition to acquiring rentals. Keep in mind, it’s not just getting your license and saying, “Hey, great, I’m a real estate agent.”

This is an hourly test: 750 hours and more than half your total working time. So if you’re going to become a real estate agent to help you qualify, you need to make sure you’re actually out there generating commissions—truly being an agent, not just one in name only.

One last thing: you do not need to be a real estate agent to qualify. That’s a common misconception—“I need to be a real estate agent to be a real estate professional.” This is not the case.

Thomas Castelli, CPA (10:54.101)

So that’s one strategy: real estate agents and brokers. Another one is, in addition to acquiring rental properties, you could become a wholesaler and/or a flipper. Both of those fall under categories Ryan mentioned, and they can help you get to the 750-hour requirement.

Material Participation in Rentals

Ryan Carriere, CPA (11:13.772)

Yep, and two things I want to mention there. Some of you listening are not currently in a real property trade or business and are thinking of ways to get into that. What Tom just mentioned—becoming a realtor, wholesaling, flipping—are great examples. They can be simpler in some cases than becoming a general contractor or property manager. That’s one route.

Another thing is, some of you listening might already be in these real property trades or businesses. Maybe you’re a realtor or a general contractor. Again, make sure you first and foremost fall into that 750-hours-plus-more-than-half-your-time test. But we’re going to get into step two—material participation—here in a bit. A common misconception I hear from new clients is, “Hey, I’m a real estate agent, so I qualify for this.” Not necessarily.

Maybe you meet the first step, but where we’re going next with this is the material participation in your rental properties. That’s the completion of making those long-term rental losses go from passive to non-passive. So it’s not just “I’m a realtor, so I qualify.” There’s more to it.

Thomas Castelli, CPA (12:57.299)

Yeah, that’s an excellent point. Thanks for clarifying, because if you work in one of these other real property trades or businesses that’s not rental, you can meet that 750-hour requirement, but that alone just makes you a real estate professional. You still need to materially participate in your rental properties. So if you got the 750 hours and more than half your total working time only on a rental business, then congratulations—you probably hit the material participation tests on the way to that 750 hours, and you’re good to go.

But if you’re an agent, wholesaler, or flipper, and you have rental properties but hire a property manager who handles virtually everything, you’re probably not materially participating. That can be problematic, meaning your losses could still be passive despite you being a real estate professional.

Let’s dive into material participation. If you tuned in to our last episode or any of our other episodes where we talk about REPS or short-term rentals, you probably know what material participation is.

But if you’re new, maybe tuning in for the first time, or need a refresher, there are usually three tests people look at first:

• You spend more than 500 hours on the activity. (We’ll get more into the “activity” in a second with grouping and all that stuff.) If you met the 750-hour requirement only on your rentals, you already hit that 500-hour test, so you’re good.
• You do substantially everything yourself. (You’re a one-person show with little to no outside help.)
• You spend more than 100 hours, and nobody else spends more time than you on that activity.

You want to make sure you meet at least one of those three tests for your rental activities, in addition to meeting the 750-hour and more-than-half-your-working-time requirement.

Ryan Carriere, CPA (15:11.202)

Yep, and like Tom said, there can be overlap. You could have 750 hours in your rental properties, and that would simultaneously qualify for the 750 hours plus more than half your total working time test. There is overlap. One distinction: if you’re just a realtor in another capacity, say you put a thousand hours there over the course of the year, that’s separate from material participation in your rental properties. So you need to understand the nuances—where does it overlap? It’s really all about time in your rental properties.
I don’t know if Tom mentioned this, but there are a total of seven material participation tests. We’re hitting the three most common that we usually see applying here.

The Grouping Election

Thomas Castelli, CPA (16:12.905)

Yeah, we’ll summarize all this toward the end of the episode, so if you’re trying to piece it together, don’t worry. We’ll bullet point it. One thing I want to mention before we get into what counts as material participation is the grouping election. When you qualify as a real estate professional—that’s great—but we just talked about the material participation tests. Theoretically, you have to meet one of these tests on each of your rental properties if you have more than one. If you have ten rental properties, you’d have to meet one of those three tests on all ten—unless you make a grouping election.

Once you qualify as a real estate professional, you can make the election (for tax nerds out there, or for people who need to tell their CPAs, it’s under Section 1.469-9). Sometimes they call it the “dash-9 election” or the “REPS grouping election.” Basically, you make this election on your tax return, and you’re going to treat all your rental activities as one activity. In other words, if you have 10 rentals, they’re now treated as one for purposes of material participation. So you only have to meet one of those three tests across your entire rental portfolio, which is a lot easier than trying to meet it for every single property.

Documenting Your Time

Ryan Carriere, CPA (17:42.112)

Absolutely. If you can group them, it’s obviously going to be easier to accumulate enough hours the more properties you have. A quick comment: If you’ve only got one long-term rental, it is going to be very difficult to meet real estate professional status. The more you have, the more time you’ll spend, the more you’ll be managing instead of relying on a property manager, and the easier it is to rack up those hours.

Maybe we can move into the specifics of what types of hours actually count.

Thomas Castelli, CPA (18:17.341)

Right. Not every second you spend on your rental properties counts toward the real estate professional status. The time that generally counts is the time you spend on the day-to-day operations of the property. A good litmus test is: if your activities aren’t impacting the operations of the property, then it’s probably not material to your business.

So a quick bullet list of the time that typically does count (and then we’ll get into what doesn’t count) would be listing your property for rent, showing the property to tenants, doing tenant reviews and screenings, credit checks, things like that, inspecting the property, handling repairs, maintenance, and capital improvements yourself, or coordinating other people to do those activities. If you get to a certain point where you do have property managers but you’re still actively involved, time spent coordinating with them can also count. That can include evictions, etc.

Ryan Carriere, CPA (19:43.628)

I’ve got a short list in front of me. I picture two main categories: the “physical” tasks and the “management” tasks.

• Physical tasks: Doing repairs, improvements, cleaning units, maintaining the grounds (mowing the lawn, shoveling snow), purchasing supplies, inspecting the property, etc.
• Management tasks: Showing the property to prospective tenants, placing ads online, taking applications, screening tenants, negotiating leases, communicating with tenants, collecting rents, evicting tenants, and so on.

Thomas Castelli, CPA (20:56.713)

Right. And to a lot of people out there, this sounds like work—because it is work. The real estate professional status is put in place for people who are full-time in real estate, actively working in the industry. It’s not meant to be passive. Many investors get into real estate for the tax benefits, passive income, or to build wealth. A lot of those who want passive might be shocked to hear this. If you hire a property manager, buy a turnkey property, and you’re not doing much besides reviewing financial statements, that’s probably not counting as material participation. Those are considered investor-level hours, and that time won’t count.

So, if you’re looking to qualify as a real estate professional, or your spouse is, you basically need to look through the lens of a property manager. That’s pretty much the role you’ll be taking on.

One thing I’ll note: just like the short-term rentals, you need to document your time. Documentation is crucial in the event of an audit to prove that you met the requirements. This isn’t criminal court where you’re innocent until proven guilty; with the IRS, it’s on you to prove that you met these requirements.

People track their time with spreadsheets, Clockify, Toggle—various time-tracking apps. You want to track your time proactively and not neglect it, because big tax savings are at stake. If you’re not taking it seriously, and you are audited, you could face back taxes, penalties, and interest. We’ve seen it before; there are dozens of tax court cases. We’ve reviewed some on the show in the past, and you don’t want to be in that position. So just do your time log if you’re looking to qualify.

Ryan Carriere, CPA (23:25.792)

Yeah, and if you’re thinking of a spreadsheet, I’d say 80 to 90 percent of people use something on Google Drive, for example, that’s accessible and convenient. The bullet points for what’s included on that time log:

• The date—when did you do this?
• How much time did it take? (Hour, 15 minutes, 30 minutes?)
• Description of what you did (e.g., “Fixed the toilet at Unit 2”).
• Who did the work? (You or your spouse, if married?)
• Which property, if you have multiple?

That’s really the baseline. Some people take it further by adding pictures, because a picture’s worth a thousand words, but that’s not necessarily required. The courts have called out time logs that don’t make sense. So a picture can help, but it’s not absolutely necessary. The main things to document are those five items.

Summary of REPS and Other Key Points

Thomas Castelli, CPA (25:12.373)

Absolutely. Let’s take a quick second to summarize, and then we’ll touch on any other points relevant to today’s episode for people thinking about the real estate professional status, also known as REPS.
All rentals are passive by default, meaning losses from rental activities cannot offset W-2, active business income, or other non-passive income.

High-income earners can work around this by qualifying as a real estate professional (REPS). This allows you to make your rental losses non-passive so they can offset other income.

To qualify, you spend more than 750 hours and more than half your working time in a real property trade or business. With all the court cases, it’s virtually impossible to qualify if you have a W-2 job, so your spouse might be able to qualify.

If your spouse qualifies, you don’t combine hours for the 750-hour test—one spouse has to meet it alone.

Once you meet those criteria, you’re a real estate professional, but you still have to materially participate in your rental activities by meeting one of the three main tests (500 hours, 100 hours with no one else spending more, or doing substantially all the work yourself). If you got the 750 hours only on your rentals, you already hit the 500-hour test.

That in a nutshell is how you qualify as a real estate professional. One more thing we didn’t discuss today is how you really maximize the benefits. Once your rentals are non-passive, you can leverage cost segregation. We won’t go through a total teardown of cost segregation here, but basically it breaks down the components of your property into various class lives (because a long-term rental is usually depreciated over 27.5 years if it’s residential, or 39 years if it’s commercial). Not all components are 27.5 or 39 years, so a cost segregation study breaks it down, and you can combine that with bonus depreciation.

As of right now (2025, as of this recording), it’s 40% bonus depreciation, meaning you can depreciate 40% of the value of those components in the first year. However, we know the new administration wants to, and there’s bipartisan support, to extend or bring back 100% bonus depreciation. It’s widely expected that’s going to happen for the 2025 tax year, so I wouldn’t be surprised if we see it. If it does come back, that will make REPS and the short-term rental loophole (which we discussed in the last episode) even more powerful.

But as it stands today, combining real estate professional status or short-term rental loopholes with cost segregation and bonus depreciation is still one of the most lucrative tax strategies if you’re looking to reduce taxes on W-2 income or active business income.

Closing Remarks

Thomas Castelli, CPA (29:49.877)
If you’re interested and need assistance navigating this—these are complex strategies, and there are a million and one questions you could have about how to properly apply them to your situation—we are accepting clients. Now is the perfect time to start tax planning for 2025. You can request an initial discovery call; we’d love to learn more about your situation and how we can help.

See you next week on the Tax Smart REI Podcast!

Disclaimer: This podcast summary and transcript were partly generated and may contain some errors or miss key points from the audio recording.