How to Safely Take the Real Estate Professional Tax Deduction

You can’t simply get a real estate agent license and hope to qualify.

One of the hottest real estate tax strategies is the Real Estate Professional. The IRS is on to this one, though, so make sure you follow the rules.

If your income is over $150,000, you can not take advantage of your real estate passive losses unless you are a “Real Estate Professional.” These losses aren’t lost forever. Instead the real estate losses are suspended until a future date when you can take advantage of them.
If you want to get the tax advantage, though, you’re going to want to be a Real Estate Professional.
There are two parts to using the Real Estate Professional exception:
(1)  You or your spouse must qualify by spending 750 hours or more per year in real estate activities, plus you must spend more hours in real estate activities than any other trade or business, and
(2)  You and your spouse together must meet the material participation rules.

The “Real Estate Professional” Qualification

It has to be either you or your spouse.  You can’t add your hours together. You need to have BOTH 750 hours or more, plus you need to spend more time in real estate activities than any other trade or business.
One of the areas that gets people in trouble here is that there are two parts. You need to get 750 hours or more per year, AND you need to get more hours in real estate activities than in any other trade or business. You can’t simply get a real estate agent license and hope to qualify.

The “Material Participation” Test

The second part is the material participation test. This means that you must have 500 hours or more per property in material participation.  The good news is that you can combine hours with a spouse for this one. The bad news is that it’s 500 hours per property. If you have 10 properties, that means a total of at least 5,000 hours. There is a way around that.  It’s called aggregation.  We’ll cover more on that in a minute.
The biggest challenge you can face with the material participation test is an IRS challenge to the activities themselves. They want to see that you put the active in activity.
If you have a property manager, you’re going to have a tougher time proving that you are involved with the business. They want to see that you are active and doing something, not sitting in your home office checking in via the Internet and phone.
The concept of aggregation and material participation can be complicated.  We’ll cover it–and strategies to avoid the possible tricks in the next article in this series, 3 Tricks to Winning the Material Participation Test

By Diane Kennedy

Diane Kennedy (born 1956) is an American CPA, speaker, and financial writer. She is the author of The Wall Street Journal and Business Week bestsellers, Loopholes of the Rich and Real Estate Loopholes as well as The Insider's Guide to Real Estate Investing Loopholes, Tax Loopholes for eBay Sellers, and Smart Business Stupid Business.