Not all real estate investors are created equal in the eyes of the IRS, which means not all tax planning will work for everyone. Here are some guidelines and I am hoping this will help you implement right tax strategy. You need to know where you fit to maximize your tax savings and minimize tax issues. You may even find that you fit in more than one place!
Real Estate Professional
A real estate professional is someone who:
- Owns 5% or more of a real estate business, OR
- Spends a minimum of 750 hours per year working exclusively on real estate activities, OR
- Spends more time on real estate activities than anything else and still meets the 750 hours per year rule.
If you are a real estate agent, you're most likely paid as an independent contractor. That independent contractor income is your business, and so you qualify. However, if you are paid as an employee of a real estate agency and do not own a minimum of 5 percent of the company, then you won't qualify under this provision.
If you can qualify as a real estate professional you now have the ability to offset 100% of your real estate losses (which can be significant on paper). If you can't qualify as a real estate professional your losses are limited to $25,000, and that's only if your income is under $100,000. The $25,000 starts phasing out after that and disappears entirely once your income hits $150,000. But, if you're subject to alternative minimum tax then this strategy won't work in either case, because you can't write off these losses against AMT.
Real Estate Investor. A real estate investor is someone who passively invests in real estate for long-term periods (one year or more). Any type of real estate counts here, from single family homes to industrial parks to bare land to anything in between. You can own properties that you are doing rent-to-own programs with, and have a sitting tenant and ongoing purchase option.
Real Estate Developer. A real estate developer is someone who develops property, typically from bare land (although if you buy and rehab properties there are times when you could also be considered a real estate developer). The key to determining whether you are a developer is whether you must perform work to put the property into service. The development might be subdivision, land improvement or even rehabbing a property. You would be treated as a developer during the time that you held the property before it was put in service.
Real Estate Dealer. Any time you purchase real estate with the intent of selling it for more than you paid you are in the business of real estate. At seminars I tell people that: "flipping burgers or flipping houses - it's all the same to the IRS." If you buy and sell properties fairly quickly; if you work the foreclosure market; if you look for undervalued, under-maintained properties to renovate and resell, you aren't a real estate investor - you are a real estate business owner.
Sonja Babic with Prudential Clear Water Realty is you New Bern and North Carolina Real Estate Broker! Looking for waterfront, historic or golf? We have it all! Conveniently located and with so much to offer New Bern is a great place to work, play and retire!
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