Taxpayers Guide to LLCs and S Corps
Expat and Expatriate KB
Rental Property KB
Other Tax Information KB
Small Business KB
- Articles coming soon
What is the definition of real estate professional?
To be a real estate professional, an individual must spend the majority of his or her time in real property businesses which include development or redevelopment, construction or reconstruction, acquisition or conversion, rental, management or operation, leasing and / or brokerage.
In addition, more than half of the personal services performed in all businesses and activities during the year must be performed in real estate activities. If you have another full-time job in which you work 40 hours a week, you will need to work more than 40 hours per week in your real estate business. That can truly be a hard sell to the IRS.
Second, your hours worked in the real estate activity must be more than 750 hours. Any work performed as an investor cannot be counted. Taxpayers are required under Income Tax Regulations Section 1.469-5T(f)(4) to provide proof of services performed and the hours attributable to those services.
One spouse alone must meet both tests (more than 50% and 750 hours). This is different than the material participation tests where the hours spent by a spouse do count. Also, services performed as an employee do not count unless the employee is at least a 5% owner.
If you own multiple rental properties each will be considered a separate entity and you must satisfy the above requirements on each property independently unless an election is made to treat all those interests as a single activity. This election is simply a statement that is attached to your tax return. And under Revenue Procedure 2010-13, you can make the election retroactively (typically requires amending a tax return just for the election).
These tests are applied annually. So, a rental property owner may qualify as a real estate professional in some years but not in others. And if your spouse qualifies as a real estate professional (for example, a licensed realtor) but you do all the work for the rentals, that satisfies the test (assuming a married, filing joint tax return is filed).
The IRS’s Audit Techniques Guide (ATG) directs auditors to check the occupation block on tax returns to see if taxpayers report real estate professional or something else. This alone will not disqualify you, but it goes to your state of mind. The ATG also tells auditors to review all activities including K-1s from partnerships and W-2s to assess how much time is spent on other activities.
Wait! There’s more.
Once you qualify as a real estate professional, you must materially participate in the operation of your business (rental properties). This is where it gets tricky. See What is active participation versus material participation?