Tax Planning: Real Estate Professional
All rental activities are treated as passive, regardless of the individual owner’s extent of participation. As a result, rental losses can only be used to offset other sources of passive income. If the owner doesn’t have any passive income or enough of it to fully offset the losses, then the excess losses are carried forward to future years. However there is an exception to the rule: “real estate professionals”. Those are the individuals who earn their living in real estate.
To qualify as a real estate professional, IRS requires a taxpayer to satisfy two quantitative test:
1. More than one-half of the personal services you perform in all trades or businesses for the tax year must be performed in real property trades or businesses in which you materially participate (you must spend more hours on real estate activities than non-
real estate activities, to prove that you earn your living in the real estate world), and
2. You must perform more than 750 hours of services during the tax year in real property trades or businesses in which you materially participate. (This minimum-hour requirement prevents a retiree who spends 400 hours a year managing a rental property from qualifying).
The term “real property trades or businesses” encompasses far more than simply the rental of property; in fact, the statute lists nearly a dozen activities that constitute a real property trade or business, including development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage.
“Material participation” by itself has a whole set of criterion that needs to be satisfied to be considered a real estate professional.