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Why is it better to be a "Real Estate
Professional"?
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To say it in one line: Real Estate
Professionals
can deduct unlimited losses
from rental property, other investors
can't.
I'll clarify this later, but here's
the technicality:
material participation
in a passive activity
(like owning rental property)
results in
non-passive treatment of the income.
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This is what that means: |
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Most
of us know that investors can deduct
up to $25k in losses from rental
property, but this tax benefit is
phased out for households making
more than $100k, and completely
phased out for income over $150k.
Their passive losses (rental losses)
must be carried forward until they
can be offset with future passive
(rental) income. |
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So a doctor, for
example, who makes $150k a year cannot deduct
any rental losses from income... unless the
spouse is a real estate professional...
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That's because the only way to
deduct rental losses (passive
losses) from non-passive
income (wage
or other income) is by
materially participating in the
activity, resulting in
non-passive
treatment of the income.
People that materially participate
in real estate are considered "Real
Estate Professionals" and their
major benefit is that their losses
can be unlimited.
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If you or your spouse’s answer
to any of these tests for
determining material
participation is yes, it is
considered material
participation, and you can treat
your rental income as
non-passive and claim unlimited
losses:
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1. Do you work more
than 500 hours a
year in the
business?
2. Do you do most of
the work? If your
participation is the
only activity in the
business, you
materially
participate…(ie sole
proprietor with no
employees)
3. Do you work more
than l00 hours, and
no one works more?
If you put in l75
hours a year and an
employee works 190
hours a year, you do
not meet the
material
participation test.
4. Do you have
several passive
activities in which
you participate
between 100-500
hours each, and the
total time is more
than 500 hours? The
following activities
should not be
included in the
above test: rental
activities,
activities involving
portfolio or
investment income,
and activities in
which the taxpayer
does most of the
work.
5. Did you
materially
participate in the
activity for any 5
out of l0 preceding
years (ie taxpayer
who retired and
children now run
business, but
taxpayer stills owns
part of partnership)
6. Did you
materially
participate in a
personal service
activity for any 3
prior years?
Personal service
activity includes
fields of health,
law, engineering,
architecture,
accounting,
actuarial science,
performing arts and
consulting.
7. Do the facts and
circumstances
indicate that you
are a material
participant?
This test does not
apply if:
a. you worked
less than 100 hours
a year
b. any person,
other than you,
received
compensation for
managing the
activity
c. any person
spent more hours
than you managing
the activity
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So, to sum it up,
regular investors
have "tax limits",
and real estate
professionals don't
- Real estate
professionals can
claim unlimited
investment property
losses against their
AGI regardless of
how much they or
their spouse earns.
People at high
income brackets
cannot due to loss
limitations, so many
of them resort to
becoming real estate
professionals.
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I hope this explanation was easy to understand and
hope that it can be helpful for you or your clients.
To learn more about deductible losses and material
participation check out RealTaxTips at
TReXGlobal.com.
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