For tax purposes it can be beneficial to be considered a real estate professional. Being a real estate professional offers benefits but also has requirements. If you can qualify as a real estate professional, then you avail yourself many tax advantages and tax savings opportunities.
Let’s clarify what a real estate for professional tax purposes actually is.
What is a Real Estate Professional?
A real estate professional, for federal tax purposes, is an individual who is engaged in a real estate trade or business and meets certain criteria as set forth by the tax code.
To qualify as a real estate professional, an individual must meet two requirements:
1 Material participation: The individual must materially participate in the real estate trade or business. Material participation generally means that the individual must be involved in the day-to-day operations of the business and must have a significant role in making decisions regarding the business.
2 Time requirement: The individual must spend more than 50% of their working time during the tax year in real estate trades or businesses in which they materially participate. The actual number is 750 hours of service in real property trades and business
If an individual meets these requirements, they may be eligible to take certain tax deductions related to their real estate business. One example would be deductions for rental losses or depreciation expenses. It is important to note that the rules governing real estate professionals for federal tax purposes are complex.
What is a Passive Activity?
For federal tax purposes, a passive activity is any activity in which the taxpayer does not materially participate. Material participation is determined by the taxpayer’s level of involvement in the activity. Passive activity rules apply to individuals, estates, trusts, closely held corporations, and personal service corporations
Examples of passive activities include:
1 Rental activities: Rental of property where the taxpayer does not materially participate in the rental activity.
2 Limited partnership investments: Limited partnership investments in which the taxpayer is a limited partner and does not materially participate in the partnership’s business activities.
Passive activities are subject to specific rules under the tax law. This includes limitations on deducting losses and restrictions on using losses to offset other items of income. In general, losses from passive activities can only be used to offset income from other passive activities, unless the meets certain criteria for being a real estate professional.
Why Is This important?
For real estate professionals investments in real estate become treated as active trades or businesses even though real estate is a passive activity by definition. As a result, the real estate professional is allowed to deduct real estates losses in many circumstances. This is as opposed to a non-real estate professional who can only deduct passive losses against passive income.
It is important to note that the rules governing passive activities for federal tax purposes can be complex. This is why individuals should consult with a qualified tax professional for guidance on their specific situation. For more information about this, click the link below to get in touch with us.