How to Qualify as a Real Estate Professional

In part 1 of our three-part series, we explained what real estate professional status means and the significant impact it can have on your tax return. In part 2, we will discuss the specific qualifications required to receive the benefits of being a real estate professional. A real estate professional is a taxpayer who spends more than half of their time working in real estate with a minimum of 750 hours per year. However, it is critical that the taxpayer also materially participates in the real estate activity.

How to Qualify

For the taxpayer to benefit from real estate professional status, the individual must also meet one of the seven tests for material participation in the activity:

1. The individual spends more than 500 hours per year in the activity.
2. The participation makes up substantially all the participation in the activity by all individuals.
3. The individual spends more than 100 hours per year in the activity, and the time spent is not less than any other individual’s time spent in the activity for the year.
4. The activity is considered a significant participation activity, and the individual participated in all significant participation activities for at least 500 hours during the year. Significant participation is an activity that the taxpayer has spent at least 100 hours on during the year. It is important to note that this does not include rental activities. Therefore, for a real estate professional to meet this test, they would need to be working in other areas of real estate, such as development, sales, or property management, and their hours would need to exceed 100 per activity and 500 in total for the year.
5. The individual met any of the other six tests in any five of the last ten years.
6. The individual materially participated in a personal service activity in any three preceding years where capital is not a critical component of producing income. Therefore, a rental activity would not qualify, as it requires significant capital, but a real estate broker likely would, since the income is mainly from commissions on sales.
7. Consider all facts and circumstances, but must participate for a minimum of 100 hours in the year. If any other person receives compensation for managing the activity or spends more hours managing than the taxpayer, the taxpayer would not satisfy this test.

If the real estate professional meets any of the above requirements and is involved on a consistent basis, the material participation test is met. As a result, any expenses generated from real estate activity can be deducted, not limited to rental income. This is because the rental activity is considered nonpassive and is therefore no longer limited to passive income. A loss generated from the real estate activity can offset other nonpassive income, such as wages or non-employee compensation, causing a meaningful reduction in an individual’s tax liability.

In part 3 of our series, we will discuss the aggregation options available which can produce significant tax savings.

Questions? Ask a WG Advisor.