Real Estate Professional Status Under IRS Attack

Real Estate Professional Status Under IRS Attack
© 2008 Diane Kennedy, CPA/Tax Strategist

The Real Estate Professional status has been a great loophole and, actually still is, if you follow the rules. But the IRS has found a few people who were taking advantage of the rules and so they’re on the hunt for anyone using this designation.

Here’s what the rules were three years ago: If you made under $100,000 adjusted gross income, you can deduct $25,000 in real estate losses. If you make over $150,000, you can’t deduct anything. In between, the deductible amount phases out. The exception is if you’re a real estate professional. Thousands of people then took the steps to legally qualify as a real estate professional. And now, it looks like the IRS is challenging that definition.

A primary target is the real estate agent herself. One of our USTaxAid/TaxLoopholes community members reports that he’s currently under audit for taking the real estate professional deduction on his joint return. His wife is a real estate agent, does not have any other job and reports the commissions she receives through her legitimate business. Because she claimed the real estate professional status, they then took 100% of their real estate losses against their other income.

The IRS auditor has taken the position during the audit that because one of the requirements is that she is “brokering” deals, she isn’t qualified because she’s not a licensed broker.

Apparently there have been a few cases of IRS auditors in California taking this position. I know of two cases that are planning to fight it in Tax Court. If they win, we’ll have a precedent that might stop the IRS tactics. But, if they lose, everyone who has claimed the Real Estate Professional loophole based on being a real estate agent needs to be prepared for an audit.

The timing for this aggressive IRS audit crackdown couldn’t be worse. At a time of dropping home values, tightened credit and a general malaise in the housing market, an aggressive IRS audit specifically targetting the people who are suffering the most in this economic time can’t be good for anyone. But the IRS has their job too and that’s to raise tax revenue.

One more horror story from my USTaxAid/TaxLoopholes forum:
“We just got hammered by the new IRS restrictions for being a Real Estate Professional. The IRS has just finished an audit for my wife and me for the 2004,2005,2006 tax years. We have several rental properties in Missouri. We have been using a CPA as a tax advisor over the last several years. I have felt that he is well qualified with real estate business in order to to help us understand and document the activities that would qualify my wife as a real estate professional. I have a full time job, and we had declared my wife to be a real estate professional. This was her only occupation. Since our joint income has been more than $150,000, we believed that having her qualify as a Real Estate Professional would enable us to take depreciation and other passive losses every year as they have occurred on our rental properties. However, as a result of the audit, the IRS has decided to disqualify her as a Real Estate Professional.

According to the IRS audit team (yes, more than one auditor was involved), over the last three years, the IRS has been researching the topic of Real Estate Professional for quite a while and there is now a very detailed internal IRS publication used by auditors to determine Real Estate Professional status and has now very detailed information about what activities qualify as valid activities for a Real Estate Professional. The IRS audit team used these new standards to review every hour of activity that my wife documented for each year as a Real Estate Professional. It is my perspective that the IRS is really getting on the warpath about Real Estate Professional status. We were very diligent in keeping track of my wife’s activities, recording on a daily calendar every activity that she did in support of our real estate LLC. The IRS went through this diary very carefully, and, according to their new Real Estate Professional guidelines, disallowed many of her hours. They disallowed enough hours so that she no longer had 750 hours of qualified activities each year. As a result, many of our passive losses in each tax year were disallowed.

Some of the activities that were disallowed were:
1. Researching the market for new properties (!!!)
2. Overseeing repairs done by a contracting company.
3. For those properties where we used a property management company, any coordination with the property management company was not an allowable activity.

The activities that were now categorized as unqualified activities have really surprised both our CPA and us, especially that you could not include hours that were spent in search of new real estate investments.

The final ruling of the audit expressly said that in order to qualify for Real Estate Professional status, that someone needed to put in 750 hours in directly and actively managing and maintaining their own properties and tenants, and that it did not include hours spent in working through a property management company. In my opinion, these new standards for qualified activities of a Real Estate Professional means that a Real Estate Professional would have to own quite a few properties. Now, we will be able to claim most of our passive losses for a property in the tax year that we sell that property. However, In the meantime, we had to pay tens of thousands of dollars in back taxes, interest, and penalties for the tax years of 2004-2006.”


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108 Responses to “Real Estate Professional Status Under IRS Attack”

  1. Tom says:

    How about auditing the CEO/CFO etc…crooks who stole billions of our tax money;; where is the IRS then? How about auditing the Citibank million dollar tax payer airplane? How about auditing the Wells Fargo billionaire welfare bailout?? Where’s the IRS then….go after the little guy. No rights.

    Funny how they only go after the little people trying to pay their bills and have some rental?

    It is embarrassing to be an American.

  2. Joe says:

    Why is it legal to apply “new IRS restrictions” on the real estate professional status in 2008-9 on taxes filed in past years , when the restrictions were not in effect until now, or clearly stated in the tax law. Laws in effect, as well as their interpretation, in 2005 should apply to those taxes filed in 2005. You can’t write the rule today and apply them backwards. It is illegal as well as wrong to expect folks to know and anticipate future interpretations.

  3. The problem is that tax law is comprised of so many pieces. There is the IRS Code that says what to do in very general terms, then the IRS Regs tell us how to do it and Rev Rulings, Procedures, PLRs and court cases round it out.

    The IRS, I believe, is trying to force the hand of taxpayers who took this deduction and make them force the issue in court. The IRS is kind of in a “no lose” situation. They have lawyers on staff to fight the issue and if they make a taxpayer loose, they have precedent.

    Is it fair? No. I don’t think it is either. Figure as much as $50,000 to fight a lawsuit.

  4. sam says:

    SO, I AM STAY AT HOME MOM, MANAGE TWO RENTAL PROPERTIES WHICH I OWN. I DO NOT HAVE A MANAGEMENT COMPANY OR ANOTHER JOB. THIS YEAR I CAN ACCOUNT FOR ABOUT 750 HOURS ON BOTH PROPERTIES IE PAYING MORTGAGE, TALKING TO TENANTS, VISING THE PROPERTIES, PAINTING, CLEANING ETC…I AM NOT A LICENSED PROFESSIONAL.. WILL I HAVE PROBLEMS IF I CLAIM THE REAL ESTATE PRO STATUS..sam

  5. sam, please come over to http://www.TaxLoopholes.com. I have a number of blog posts over there on the real estate professional status. You may be able to qualify, but this is definitely something you don’t want to make a mistake on. The IRS is really on the attack in this area.

  6. I’ve been engaged in taxations for lengthier then I care to acknowledge, both on the individual side (all my working life history!!) and from a legal stand since passing the bar and pursuing tax law. I’ve furnished a lot of advice and corrected a lot of wrongs, and I must say that what you’ve put up makes utter sense. Please continue the good work – the more people know the better they’ll be equipped to deal with the tax man, and that’s what it’s all about.

  7. Josh says:

    Diane,
    I purchased 10 properties in the Go Zone in 2007. As I understand it, research does not qualify as active participation, but “acquisition” itself qualifies as active participation. After purchase I used a property management company for 6 of the properties. Does the use of property management NEGATE the hours I put in acquiring the property? Also, I run and manage the HOA for these properties – oversee management of the entire development. Does that management qualify as active?

  8. Diane says:

    The property mgmt company won’t negate any hours. The challenge that you’d get in an IRS audit is whether you managing the property management company is active enough. If you had enough hours from other activities – finding the property, fixing it up, etc..

    Tricky on the HOA management. Hours count if you own 5% or more of a company. But if you work at a non-profit, then you can’t own it, so the hours won’t count.

  9. Liam says:

    We have benefited from the Real Estate Professional exception now for years and so far without any problems.

    A common theme I find running through most of these cases is the owners really didn’t manage the property or the hours reported are absurd. Take a Denver physician and his wife who claimed to be full time managing their two ski condos and writing down time spent driving to the mountains on ski weekends.

    Another common one is like the gentleman above. If you have a management company interviewing tenants and leasing units and you only own a few how does that occupy most your time? Especially if they were rented for most of the year without too much turn-over? Isn’t there a smell test on what is reasonable regardless of what you “documented” on a piece of paper?

    Those cases are easy to understand why they were audited. What about owners with multiple properties they really actively manage? Do you need to own more than 5 or 8 or 10 before it seems reasonable you spent 750 hours on them?

    I wish someone would investigate the true guidelines and focus on discussing the ability to use the loophole for those of us who own and manage rental properties.

    In my case I have a full-time job with an active income over $150,000. My wife really does manage the rental properties from home without having any other job so we deduct those “passive” losses against my active income.

    Does anyone know what objective criteria the internal IRS audit manual uses to trigger an audit? Number of houses, minimum percent of ownership and other specifics would really help everyone forllowing this issue.

    Thanks

  10. john says:

    This is a very interesting blog and i appreciate everyones inputs. I started buying, renovating, and renting out real estate this year and I have quite a few units operational already – many more coming for 2010. I spend the vast majority of my time doing the real estate activities mentioned above, but I take a full salary from my wife’s advertising agency for “consulting” work. Quite frankly, after what i have read, I am afraid to declare myself a real estate professional even though i could easily document the 750 hours. It may be difficult to show that my “consulting” is less than 50% of my time, since we do not track our hours for the advertising agency. The hassle of the audit and possibility for all the back payment, interest and penalties is terrorizing. This is nuts. Why does this country want to beat up on the little guys? Isn’t there enough big guys out there to beat up on?

  11. Bryan says:

    Does anyone know if real estate training/education related time can count toward a portion of the 750 hours?

  12. Diane says:

    Bryan, the training and education is something that the IRS is systematically throwing out when they calculate the hours. I don’t believe that anyone has challenged the IRS on this and won.

  13. Lisa Martin says:

    Diane,

    I am a CPA,MST who does a great deal of work with real estate investors. (Let’s disregard the hassle I am going through with the first time homebuyers credit.) I have several clients that clearly (at least appear) to qualify for real estate professional status NOW and in this market. Several have prior year passive activity loss carryovers related to real estate as a result of AGI limitations. You have clearly done quite a bit of research in this area. What is your thought on converting prior year carryovers to non passive? It is quite possible that they may have qualified in prior years but did not have a tax preparer that understood the law. Can I do a retro amendment or is there a “timely filed” requirement? Real estate taxation is a specialty area! Most investors do not understand that a “storefront” tax service is NOT going to get them all of their benefits!!!

    I’d appreciate any off the cuff input you may have. Thank you!

    Lisa Martin
    Farmington Hills, MI

  14. Diane Kennedy says:

    Hi Lisa

    The Real Estate Professional (REP) status does not have a time requirement. The other part of this, though, the material participation requirement of 500 hours per property applies. If the client instead wanted to aggregate the properties, that election must be filed with the original return.

    Hope that helps! Diane

  15. Phil Boura says:

    Diane:

    I have a client who consists of two 50% partners that rent 2 properties. They have each been claiming the Real Estate Professional status for years, but may be under audit soon. About 65% of their rental income is drawn from a self-rental (to another business that they oare involved in). The rest of the income is from a 3rd party renter. There is no turnover in tenants.
    Also, even though one of the partners may really qualify as a real estate professional, the other one will not, (based on the fact that he works greater than 50% at the other business that they own)

    Question #1: Does the self-rental “not count” in the determinatin of the 750 hours, etc, criteria? Or can we see it as a legitimate tenant?

    Question #2: If one of the partners is found NOT to be a real estate professial, will only his share of the proceeds be at risk of tax/penalties, or will the entire partnership be?

    Thanks!, Phil

  16. Diane Kennedy says:

    I’ll just assume that this is an LLC and you have two members. There would be a question as to whether the LLC is manager-managed or member-managed, but setting that question aside, the bottom line is the LLC is simply a pass-through entity.

    Each member gets a K-1 and for one the loss may be deductible and for another it might not be. So, if one has to suspend the loss, it doesn’t mean that the other one will have to. The real estate professional designation is an individual test, not a business test.

    The other issue is whether there is 500 hours of material participation per property. If not, and there was no aggregation election made, there could be an additional issue.

  17. Melvin says:

    Is there any update on the cases that were to be heard in court?

  18. Diane Kennedy says:

    Melvin,

    The IRS pretty much lost all around on the cases. Real estate agents are considered real estate professionals, provided they meet all the other requirements. But I’m not sure how good the training on this issue is. I just heard from an IRS agent based in AZ who said that ONLY real estate agents could be real estate professionals now. And that’s not right either. But I haven’t heard that he’s prevailed in any audits. (You can often get crazy auditor rulings overturned internally through the appeals process, when you get a more experienced agent looking at the facts.)

  19. Jeff L says:

    Diane,

    I am a RE Agent and my prior CPA didn’t advise me of the RE Pro advantages. So I filed an amended return for 2 previous years. I met the active requirement and had over 750 hrs for the properties.

    1) Since I didn’t file the desire to aggregate my RE properties into one on my ORIGINAL return 2 years ago, does that preclude me from being able to aggregate my properties?

    2) When I filed my amended return my CPA was not aware of the need to file a form with the amended return showing the desire to aggregate my RE properties. Am I out of luck?

    3) I have researched all the IRS regs and I do not see a “form” to aggregate your properties. How do you do that on your taxes?

    I am in the middle of an audit that is driving me crazy as the original auditor refused my deductions and would never give me a reason for that decision. We have appealed this to the next level but I don’t know what to expect as my amendment triggered the audit.

    Thanks for all your posts and help!!

  20. Diane Kennedy says:

    Jeff, I hope you’re getting some good help on the audit.

    My guess is that they are challenging your real estate professional status, and thus you’re not able to take the real estate loss against other income. But without actually talking to the auditor or seeing the papework, it’s hard to guess exactly what is happening.

    If you did not aggregate the properties, you will probably get denied on this. The aggregation is a written election that you need to make at the time you file.

    If you do get denied the deductions in the audit, and you haven’t yet filed your 2009 return, you may be able to take it in 2009, do the aggregation and pick up the losses now.

    At this point, the audit needs to be the biggest focus.

    In the future, I suggest you work with a CPA who is a specialist in this area.

  21. Shawn says:

    Diane,

    You said “The Real Estate Professional (REP) status does not have a time requirement. The other part of this, though, the material participation requirement of 500 hours per property applies. If the client instead wanted to aggregate the properties, that election must be filed with the original return.”

    What about those of us that prepared our own taxes and e-filed and were not able to send in the election to combine properties with the e-file?

  22. leah says:

    Hi, I currently own 4 homes, one of which is classified as a rental, the others are our primary, summer, and extra (in laws use). I wanted to know if the 750 hours can be spread throughout the properties or only to the rentals.

    Also can supervising construction and renovation count towards those hours.

  23. leah says:

    Also does my time spent commuting count. I live in new york and have been going to and from new jersey at least twice a week to meet with workers.

  24. Johnny says:

    It really does sound like you were abusing the definition to me. The IRS isn’t as stupid as some would hope.

    If you only own a couple properties out of state and hire a management company to manage the units, how can you possibly claim it is a 750 hour per year job? Nobody believes that is a fulltime activity.

    Too many people were using this loophole to write-off trips to their timeshares and vacation condos being managed by professionals. As someone who does manage my own dozen properties I appreciate the ability to write-off the full depreciation.

  25. Diane Kennedy says:

    Shawn, I’m sorry for the misunderstanding. The Real Estate Professional status does have a time consideration – there must be a minimum of 750 hours per year and at least as many hours as are spent in any other trade or business.

    If you did not make the election to aggregate the properties, you’re pretty much out of luck. The e-file does not work in all circumstances, as you did find out. Make sure you file it this next year.

  26. Diane Kennedy says:

    Leah,

    You can not include hours that you spent on your personal residence. The 500 hours of material participation and 750 hours (or more) for Real Estate Professional all must be related to BUSINESS, not your personal home.

  27. Thomas says:

    Hi Diane,
    I have been audited and my deduction of my real estate losses against my wife’s income is being disallowed based on the auditor’s decision a real estate appraiser is not a real estate professional. Otherwise I meet all the time requirements and the material participation requirements for my properties. Are you aware of any challenges to the IRS by real estate appraisers to determine whether they qualify as real estate professionals?

  28. Diane Kennedy says:

    I’m sorry to hear that Thomas. I’m not aware of that argument before. You may want to contact other appraisers or visit some appraisal forums to hear if it has happened to anyone else.

    One other point, some times the auditor may disallow the deduction because of material participation or due to the fact that the ownership was not proven. Also, you would need to meet both the minimum 750 hours and more hours in real estate activities than any other trade or business test.

  29. Bobbi says:

    Hi Diane,
    I am being audited for my rental property loss deductions. The number of “500″ hours per property is being quoted here. My research pertaining to the definition of material participation is telling me that 100 hours per property is the key number. I am reading something wrong? Also, if I had chosen to group my three properties would it be just one single 100 hour requirement spent to materially participate in all three?

  30. David says:

    I am being audited for being a real estate professional as well. I have 3 properties and spend 50%+ of my time on managing, renovating, fixing the properties. I do most of the work myself or work as the general contractor and hire and work with the contractor when appropriate. I am working on documenting my hours together to show 750 hours of direct manual labor.

    Two questions: 1) what is a reasonable amount of time to allow for ongoing admin duties like screening tenants, collecting rents, security deposits etc? 2) Can they really disallow my time if I act as the general contractor – hire, supervise and work with contractors?

    It seems unfair that they would disallow time to supervise contractors (I have to hire licensed plumbers and electricians at times) because I have to meet them at the building, move or clear out items, go over the job and make sure they are doing it right and or check the work before paying them.

    It is pretty clear to me that I am doing the general contracting and some of the labor – most of my major reno work is done at 25-40% of the going rate.

    Any advice is appreicated.

  31. Diane Kennedy says:

    Bobbi says:

    “I am being audited for my rental property loss deductions. The number of “500″ hours per property is being quoted here. My research pertaining to the definition of material participation is telling me that 100 hours per property is the key number. I am reading something wrong? Also, if I had chosen to group my three properties would it be just one single 100 hour requirement spent to materially participate in all three?”

    Thanks for the question – this is a common misunderstanding. The 100 hours refers to active participation. 500 hours is material. You need active participation if you have a business loss or make less then $100K and want to take the up to $25K real estate loss.

  32. Diane Kennedy says:

    David says: “I am being audited for being a real estate professional as well. I have 3 properties and spend 50%+ of my time on managing, renovating, fixing the properties. I do most of the work myself or work as the general contractor and hire and work with the contractor when appropriate. I am working on documenting my hours together to show 750 hours of direct manual labor.

    Two questions: 1) what is a reasonable amount of time to allow for ongoing admin duties like screening tenants, collecting rents, security deposits etc? 2) Can they really disallow my time if I act as the general contractor – hire, supervise and work with contractors?

    It seems unfair that they would disallow time to supervise contractors (I have to hire licensed plumbers and electricians at times) because I have to meet them at the building, move or clear out items, go over the job and make sure they are doing it right and or check the work before paying them.

    It is pretty clear to me that I am doing the general contracting and some of the labor – most of my major reno work is done at 25-40% of the going rate. ”

    If your income is over $150K and you’re using the Real Estate Professional status to get your losses, make sure you also can prove material participation on the properties. People get hung up on the REP status and forget about the 2nd part. If you have more than one property, you’ll need 500 hours per property or have done an aggregation election. Also, if you have these in an LP, you could be in trouble if your interest is mainly as a limited partner.

    But those aside, if the issue really is just the REP status, make sure your time sheets show more than 750 hours becuase they are definitely going to disallow something. If you can show proof that you did work directly on the property as a contractor, handyman, whatever that will go a long way.

  33. John says:

    Please help. I am not able to sleep or eat. I just received an IRS audit letter for 2008 and 2009. They want to discuss mainly my rental properties income and expenses. I now they want to discuss with me more than that…You know what I mean. I have filed my returns as REP and I believe I deserve the classification as I spend a lot of time managing my 4 properties located in the same area (condo). I can document the 750 hours outside my day job (consulting). I am also the HOA President where I give them at lest 2 hours a day: signing checks for workers, vendors, reviewing bids, approving bids, talking to HOA CPAs, lawyers, reviewing the books and many many other things.

    I haven’t slept for 3 days now and I am worried that I will be stuck with at least a bill of 60k after said and done. I will be devastated. Please help.

  34. Diane Kennedy says:

    John,

    You need to get a tax pro helping you immediately. If you’d like a referral to one of the experts we work with, please get hold of our office: Richard at USTaxAid.com (substitute @ for at)

  35. patricia says:

    Hi Diane-
    I was doing some extensive research for a few days now regarding this REP status for our LLC tax, and I have 3 questions:

    1) We have one 8-unit apartment complex, is that sufficient for the 750-hour requirement? In other words, is it going to raise red flags for the IRS, since I’ve read so many horror stories with people with multiple properties getting audited anyways (or maybe they’re condo owners instead of apt).

    2) I am one of the owners of the LLC; however, I read that “By definition, if you hold property in a limited partnership as a limited partner, you do not materially participate. This area is being hit hard, and the number of audits of limited partnerships has increased.” Do I need to modify the LLC so I’m not one of the owners or I’m okay?

    3) We don’t want any chance of getting audited- from what I’ve been reading, is this REP a risky route? Or maybe we should split the loss between the LLC members?

    Thank you in advance for your help!!

  36. Diane Kennedy says:

    Hi Patricia – glad you found this almost 3 year old blog entry and that it was helpful.

    There are two parts to successfully taking a REP exemption: Proving you are a REP (that’s the 750 and more hours in RE activities than any other trade or business) PLUS materially participate in your property.

    The apt complex could very qualify you for the 2nd part (materially participate in the property), but doesn’t necessarily mean you also meet the REP qualifications.

    On the LLC – depending on how you hold your interest. Is it a manager-managed or member-managed LLC? There is a lot to consider with the deduction. It’s not quite as straight-forward as we all wish it was.

  37. Melissa says:

    I need a good attorney in Huntsville, Alabama who can represent me during an appeal. I won the audit for 2004, 2005, 2006 claiming real estate professional. I was audited for 2007, 2008, 2009 and the IRS claims I am no longer a real estate professional. Different auditor. I have good records, logs, etc. just different auditor. I can’t afford to spend thousands on a lawyer.HELP.

  38. Diane Kennedy says:

    Melissa, if this is the IRS, then it is federal, not state based. That means an IRS rep in any state can help you. You do need an attorney if you’re going to tax court, but it you’re still in the audit or just got the results and want to talk to the appeals division w/n the IRS, then you can use a CPA as well.

    Drop my husband Richard a note and he can give you a couple of leads Richard AT USTaxAid.com (substitute the AT for @)

  39. william says:

    Hi very informative site. Thank you very much for your guidance.

    I have a 3 unit apt building and am “in contract” to purchase an additional 4-unit property (I will owner-ocuppy one of the 4 units and have an undivided 75% ownership interest in the overall property with a 25% passive family member partner). I am single and have never claimed REP status due to my current full time “day” job (where I earn income well above $150K threshold – so have not been able to take any RE losses). I will end that non-real estate job at the end of this month. I am interested in obtaining REP status – as my primary occupation for the next several years will be the design, permitting and extensive remodel / redevelopment and ultimate condo conversion of the new 4 unit building (using a General Contractor, structural engineer, draftmans but being very involved the architectural design, sourcing and contracting of sub-contractors, construction oversight, etc.).

    If my only occupation as of March 31 2011 is this work (and managing the existing 3 unit where there is no property manager and I already do virtually all the handyman work, painting, tenant management, etc.) and assuming I qualify in terms of the 700 hours (and file to “aggregate” the two properties), my question is if I no longer have any active income (since my day job is going away) – though I will have $150k+ of w-2 for 2011 with my Q1 2011 work and severance payments – but will likely only have passive annual income therafter – which will also likely be well in excess off $150k in, dividends (both ordinary and full taxable dividends from REIT, Prefrreds and BDC stocks) and interest income and occasional stock cap gains (both short and long term), can I offset any or all of those passive income amounts against my RE losses and if so, is it dependent on my qualifying as REP status – or are there differnet rules between active and passive income in this area?

    p.s, as I currently have only one rental property is there any issue of filing to aggregate these two properties for tax year 2011 when I close on the new 4 unit bldg – and are there any issues disadvantages in aggregating that I should consider in advance?

    Many thanks

  40. william says:

    sorry should read 750 hours above instead of 700

  41. william says:

    Also I will still be renting out the other non-owner occupied units in the 4 unit building while I design the rehab, secure permits and financing for the remodel (likely a 1 year plus timeframe . . . before any actual remodeling will begin).

  42. Ron says:

    I have a full time job. However the IRS is saying i’m not a Real Estate Professional although I can easily account for 750 hours a year by owning 30 properties and managing them myself. How many hours does it take to qualify. I have heard 750 and more than you work your full-time job.

  43. Steven Yin says:

    I received my real estate salesperson license in September 2010. Prior to getting my license, I was actively looking for investment properties and spent more than 750 hours including studying and preparing for the exam. However, I spent less than 750 hours from September through December of 2010 after I received my license. Can I claim as a fulltime real estate professional on my income tax return for 2010?

  44. Jacqueline says:

    Hi Diane – I’m so glad I found this forum on Real Estate Professional. I have a 10-unit apartment rental property and my business is incorporated as as S- corporation with my husband and I being the 50-50 shareholders. I have a couple questions:

    1. Since my rental property is set up as an S-corporation and that I materially participated in the rental property, will my wife and I be qualified as a real estate professionals?

    2. My wife and I both have a full time job as computer programmers, will this affect our real estate professional status (if we quality)?

    3. If I qualify as real estate professional in 2010 tax year, will I be able to deduct prior year’s passive losses against my non-passive income in 2010?

    Thank you so much for help!

  45. John says:

    I am in business with a partner as a contractor- remodeling, painting and landscaping, and I own 9 rental properties that I manage and maintain. The contracting takes about 1200 hours a year, and the rental properties are about 800 hours a year. Am I considered a real estate professional? If it helps to have more info- I’m a general partner and we file a 1065 for the business. Half of my hours in that business, about 600, are spent on landscaping and the other half, also about 600, on remodeling.
    Thank you for your help

  46. Diane Kennedy says:

    Hi – thanks for all of your comments. Looks like the hottest blog entry right now is almost 3 years old!

    Ron said: “I have a full time job. However the IRS is saying i’m not a Real Estate Professional although I can easily account for 750 hours a year by owning 30 properties and managing them myself. How many hours does it take to qualify. I have heard 750 and more than you work your full-time job.”

    There are two standards to taking the real estate professional exemptions: (1) You are a real estate professional and (2) You materially participate to the tune of 500 hours per property per year.

    You need both to qualify.

    (1) A REP means you work more hours in real estate activities then any other job and that you have at least 750 hours per year.

    (2) Material participation may be what is causing you your problem. 500 hours * 30 properties = 15,000 hours per year INSANE! You need to make an election to aggregate your properties so you can instead meet just one 500 hour requirement.

    WARNING: Do not enter into the aggregation election without considering what happens when you sell. You can run into tax issues if you sell at a loss.

  47. Diane Kennedy says:

    Steven says: ” I received my real estate salesperson license in September 2010. Prior to getting my license, I was actively looking for investment properties and spent more than 750 hours including studying and preparing for the exam. However, I spent less than 750 hours from September through December of 2010 after I received my license. Can I claim as a fulltime real estate professional on my income tax return for 2010?”

    The license has nothing to do with the REP designation. The question is whether you were actively working as a real estate professional. Studying doesn’t count. In TOTAl did you spend more than 750 hours? Is this more then you spent at any other trade or business?

    And please see my message above for my additional advice for Ron.

  48. Diane Kennedy says:

    John says: ” I am in business with a partner as a contractor- remodeling, painting and landscaping, and I own 9 rental properties that I manage and maintain. The contracting takes about 1200 hours a year, and the rental properties are about 800 hours a year. Am I considered a real estate professional? If it helps to have more info- I’m a general partner and we file a 1065 for the business. Half of my hours in that business, about 600, are spent on landscaping and the other half, also about 600, on remodeling.
    Thank you for your help”

    Without knowing any other information about your business and other business activities, it definitely sounds like you have active real estate activities. You do need to own more than 5% of the business and you need to be a general partner (which it sounds like you are).

    Remember you also need to meet the 500 hour requirement mentioned above.

    And by the way, consider moving your business to an LLC or S Corp – being a general partner in your own name puts all your other assets at risk. :-)

  49. Mo says:

    Hi Diane,

    I have several rental properties and wanted to know if Im a 5% owner in an S Corp and employ myself to manage the properties using the S Corp can claim REP to offset my other fulltime job?

  50. Judy Makem says:

    Neither my husband or myself is a “RE” professionals (Can’t find a definition of one)but we have 4 rental properties that my husband manages works on etc. He has taken the deduction for many years assuming he was putting in 750 hours. When he started to really put down what he did and for what amount of time, he realized there was no way that was going to work. We realize that we are going to fail the test during the audit and will probably owe a lot of money. My question is: Where do we turn to get someone to look at our taxes and see if there are other areas that may mitigate the problem. My husband has always done our taxes himself trying to read the tax code and I am wondering about other possible mistakes like should we have income averaged or other things. We just want to have our ducks in a row before the audit. Advice is appreciated!

  51. Ken says:

    Im being audited as well. I owen an 8 unit building, and three seperate 2 unit buildings. On of which I live in. So I manage and rehab my other 13 apts. I do basically everything…snow removal, land scaping complete rehabs, screenings of tenants evictions etc…etc…. I have to say my recorsd keeping is not that great ,, but I do have all reciepts and the proof is in the before and after pictures. I am about to present thease pictures to the agent soon but the feeling Im getting from him is this is not going to be enough. I mean how many properties do you need to qualify for this deduction? I have another job (36 hrs a week) but work it in three days (12 hour days). The rest of my free time is doing something on these properties but I dont think the agent is buying it.

  52. Jean Irwin Bilek says:

    I am in business as a Residential Real Estate Appraiser. I want to purchase a rental property that I will manage and maintain. My business is a Sub S Corporation. I own it 50/50 with my husband.
    I anticipate that my time will be spent as follows: (1) APPRISAL Business 1200 hours (2) Rental activities — management and maintenance 150 hours (3) Part time consulting (engineering) 700 hours.
    My questions are:
    Can I hold the property in the Sub S Real Estate Appraising (and investing) business?
    Am I considered a Real Estate Professional?
    Will I be able to take passive losses from the Sub S Corpation on my personal return?

  53. Diane Kennedy says:

    Ken, I’m sorry that I missed your comment until now. I have a feeling the audit is over. Hope it worked out!

    In general, you need to prove that you have done more hours in real estate activities then your other job and at least 750 hours per year. In your case, you’re going to need to prove that you had 37+ hours per week in real estate activities. You should have a journal or calendar to document what you would were doing.

    You also need to prove you had 500 hours per property, unless you have elected to aggregate on your tax return.

  54. Diane Kennedy says:

    Jean, under the more strict definitions that IRS auditors are using, you will not qualify as a real estate professional. Appraising is not specified as a real estate activity. (I know, I know – it’s all about real estate or else you wouldn’t be doing it!0 The Engineering also does not qualify.

    If you have real estate appraisal company losses, those can be taken against other income. Most likely the real estate losses can not be unless your income is under $100K. If it is, then you can take $25,000 of loss.

  55. Diane Kennedy says:

    Mo, probably not. You would need to have more hours in your real estate activity then any other trade or business.

  56. Diane Kennedy says:

    Judy, you might want to do a search on this site and on my companion site http://www.USTaxAid.com for the term “real estate professional.” You’ll find a number of articles and lots and lots of comments about what that means and how to qualify.

    Income averaging sadly went away a number of years ago.

    My suggestion is to have a tax pro prepare your return. But make sure the tax preparer is experienced in specifically what you do – in this case, real estate investing.

    Best of luck!

  57. Alisha says:

    Hi Diane,
    In 2009, I clearly met all the requirements to be classified as a real estate professional. However I am not sure if one of my 2010 jobs would allow me to classify. In 2010, I was a consultant for a real estate company. I did not personally lease, manage, construct, etc property. I managed a database of real estate properties that track certain attributes of those properties. Can you please let me know if you think I would qualify as a real estate professional? Would the work I did be considered working in a real property trade or business? Thanks

  58. Clydette Cutropia says:

    Hi Diane,
    I own a 16-unit apartment complex and 6 single family homes and 1 duplex. I alone acquire, hire repair people, lease out, and manage all these. I have extremely detailed docs and log book. I alone write all checks and do all the day to day activities for this rental business. I added approximately 1100 hours for 2010, which I am being audited. I have no other W2 income or children. I am wondering how worried I should be about this audit. Any comments?

  59. Diane Kennedy says:

    Clydette, It depends on what the auditor is looking for. If it is simply the real estate professional issue, it sounds like you clearly qualify and have the back-up to prove it. But they could be looking at expenses, basis or any of a hundred other items. The letter they send for the audit should give you a clue as to what exactly they want to see.

  60. Randy says:

    Hi Diane,
    I(single) currently rent out 2 out of the 3 rooms at my home and looking to get Real Estate Professional Status. So i share the common areas with my tenants. I feel like I satisfy the 750 hours, and being materially active in the property since i live/sleep there too. I have a 40 hour a week job, but since I live in the same space as the other tenants, will that make me less likely to get audited? How likely will I be audited? I feel like I’m constantly looking after place, inspecting, cleaning, repairing and providing useful supplies for the rental. I can see it would be hard to pull off real estate professional status if you have you own home, have seperate rental units, and have a 40 hour a week non real estate job. What are you thoughts on that?

    Thanks,
    Randy

  61. Randy says:

    Hi Diane,
    I was curious how do the rich, who normally have a full time job, use real estate as a tax loophole. Since they make too much to use the 25K passive rule, and can’t get the Real Estate Professional Exemption.

    Thanks,
    Randy

  62. Diane Kennedy says:

    Randy,
    A couple of distinctions here: You would need to spend more hours in real estate activities then your job. So you don’t have to meet the 750 hour requirement, you have to meet >40 hours per week requirement.

    The income you make from the two rooms will be offset by a pro-rata share of mortgage interest, property tax, HOA dues, utilities and the like.

    You have some extra cash flow that won’t be taxable, but I think it’s unlikely you’ll qualify as a real estate professional.

    - Diane

  63. Joanne says:

    Hi Diane,

    I have a full time job & have documentation that I spend 1,450 at “work”. I also have a six family building, a two family building and several single family homes. I am Married Filling Seperate status & I claim Real Estate Professional. I maintain daily logs of all my time & had notrized Affadavits form 8 of my tenants atesting to all the work I do including collecting the rent, removing the garbage, preparing leases, painting the apartments & common areas, cleaning the common areas & front & back yards, snow removal, etc. The auditor only accepted the time for collecting rent & repairs/maintenance and nothing else. I don’t understand? According to NYC Housing Code I have to maintain the common areas clean, provide garbage removal services, etc. Why does that time not count as an operating activity for Real Estate Professionals to the IRS. What can I do?

  64. Diane Kennedy says:

    Joanne,
    Did you have a representative with you during the audit? If not, get one to assess whether it makes sense to appeal. Depending on time limits, your choices (most likely) are to (1) accept it (2) ask for a supervisory review (my recommendation, if possible) or (3) formally appeal. If you go with the supervisory review, make sure you have a solid case with code and case cites. That’s where you’ll need a professional to help you. I’m sorry it happened to you, from what you say, you should have kept the deductions. My guess is that it was interpreted differently, you got an auditor who didn’t understand or someone was having a bad day. :-(

  65. William S says:

    Diane,

    Do you have to log every single hour of the year for Real Estate Professional or will the IRS accept, say 1 month that clearly shows significantly more 750 pa or 1 month each quarter?

    Many thanks

  66. Diane Kennedy says:

    Remember you have to get 750 hours and more then any other trade or business. I don’t think it would be physically possible to get that many hours in one month, but if you can and they are all clearly justified, then yes, that’s all you need.

    Personally I would recommend that you keep a full calendar and if one month is only 10 hours, so be it. But it shows intent and that you are serious about what you’re doing.

  67. Michelle says:

    I am a full time teacher in michigan and Im getting my real estate liscense. Im planning on working full time as an agent as well and I have two rental properties..Does that qualify me as a real estate professionalI am a full time teacher and I am planning on getting my real estate

  68. William S says:

    Diane,

    Thank you for your answer. I guess I wasn’t clear in my question. I’m not suggesting that I would document 750 hours in a single month. What I’m asking is would the IRS take a month, or a month for each quarter, than shows significantly more than 750/12 (62.5) hours in that sample month?

    I guess there are other advantages to keeping an accurate log of your hours too. I can show that I do significantly more that my partner!

  69. Jean says:

    Diane,

    1. If you have an expired real estate license, do you still qualify for R.E Professional Status?

    2. Does it apply for owning and managing your own vacation rental?

    3. And if so, which of the following can be included in the 750 hours?

    a. Time communicating with potential and/or paying guests ,

    b. Buying and stocking supplies for guests,

    c. Managing your cleaning crew whether you are able to be there or not,

    d. Cleaning the home yourself,

    e. Setting up your advertising campaign.

    4. What other deductibles are allowed for vacation rentals?

    5. What are the red flags or items that I should avoid declaring, etc?

    Thanks,
    Jeannie

  70. Shirl says:

    I wanted to know if we document hours looking for property or going to a property because of no money from the tenant that lives 800 miles away is a valid excuse for rental time.. I also work after hours buying and picking up supplies from Stores and we install hotwaterherters and ect.. We hire some of the work but do most of it ourself..
    My husband is a teacher so he is off all summer and 2 Weeks Christmas,2 weeks Spring Break and time for holidays.. Could he if he spends with me over 1200 hours per year managing 12 properties…

  71. Bruce says:

    Hi Diane/All

    Is there a comprehensive list somewhere of what type of hours can typically be accepted in a log? Can time spent taking classes, exams, acquiring license, etc be counted?

    Thanks
    Bruce

  72. Dez says:

    Hello. I have a full time job and my wife does not work outside of the home. We file jointly. We only have my single employer provided W2. We own 2 rental properties that my wife manages. This includes finding tenants, collecting rent, and dealing hiring out maintenance when needed. We do not use a management company.

    Two questions:

    1)

    Assuming my wife keeps detailed records that account for greater than 750 hours, will she qualify as a real estate professional?

    2)

    This is our 4th year operating managing these properties and have not previously made this designation, can we capture the past losses in our next return?

    Thanks Dez.

  73. Diane Kennedy says:

    Dez, if your wife’s detailed records show qualified real estate activities that are 750 hours or more and you have material participation (500 hours or more per property), you will likely qualify for a real estate professional.

    You could go back and amend your returns to make the designation. Remember that this extends the statute of limitations for the IRS and gives them another look at your returns.

  74. randy says:

    Hi Diane,
    Back to my comment last year. Some say that since you are living and sharing space with a tenant that you could be techincally be spending time thinking/cleaning/repairing/maintaining/working on the rental the times you are home and on the weekends, which would put you over 750 hours and also over the 40 hours a week you work on your day job. Seems like this is up to interpretation? I can see both ways. Your thoughts?

    Thanks,
    Randy

  75. Ray says:

    Hey Diane,

    My wife and I file jointly. She is stay at home mom and takes care of 1 rental property. We do not use a property manager. According to the IRS rules we are unable to use rental losses as our AGI falls us out of qualification.

    Question: Can my wife qualify as a “real estate professional” if she documents hours spent and meets them?

    Thanks in advance,

    Ray

  76. Dez says:

    Thanks Diane,

    Just a clarification.

    If I want to deduct losses from prior years, do I need to amend returns, or can I simply carry forward those losses which were ineligible in years prior before making the real estate professional designation?

    I think this would go in line 1c of Form 8582 (Prior years unallowed losses)

    If so, it would mean just waiting to take these losses next year, rather than filing amended returns, which I think would be preferred.

  77. Carol Hurwitz says:

    My husband and I are being audited for claiming the Real Estate Professional 100% deduction of rental losses. He is the licensed real estate broker and I am not, but I was the one doing all the work managing and handling our rental properties (2 duplexes in state, and one home out of state). I easily worked 750 hours per year on this; it was all I did, no other job. We deducted 100% of our losses against my husband’s income. As I understand it, our accountant failed to make an ‘election’ to combine all 3 properties (which would have allowed me to work a total of 750 for all 3 properties). As I understand it, without this election you have to have worked 750 on EACH property. Thus, we may be out of luck? Do you know anything about this supposed required election to combine the properties? Do you know if you can make it retro-actively? Do I understand this “election” correctly? Any help at all is greatly appreciated.

  78. Diane Kennedy says:

    Carol, there is a new Revenue Procedure 2010-13 that allows you to make the election retroactively. Unfortunately, it’s so new that most IRS auditors are not familiar with it. Make sure you have good representation through the audit who is aware of the real estate issues like this. BTW, it sounds like your husband is the real estate professional and you met the material participation requirement, which is perfectly okay.

  79. Diane Kennedy says:

    Dez, the unallowed losses from the prior year should continue to roll forward on your return. Unless you didn’t properly report something in the prior years, I would not suggest that you amend the returns.

  80. Hope says:

    Diane, my husband and I have received a letter from the IRS stating that they are disallowing our Real State professional election for our 2009 return, as they said that we did not actively participate more than 750 hours for each property (we own 6 properties back then) and added that the following activities do not count towards the 750 hours: Collecting deposits/income, depositing deposits/income, cutting the grass, shoveling the snow, maintaining the premises, answering phones, checking the mail, drive-bys and tax preparation.

    My husband is solely dedicated to our real-state business and does not have any other job and he is the one that does everything for those properties, renting them, prospecting for new tenants, all the repairs, collecting the rent, etc. He solely manages all the properties.

    Is this right? can they disallow the time he spend doing the repairs and/or collecting the rent? I would truly appreciate any help that you can give us. Thanks!

  81. Gina says:

    Hi Diane,

    I’ve read some of your books and they are really helpful. Thanks. As you probably know, California does not recognize the Real Estate Professional status. Do you know of some other means to reap the benefits of this status for my state taxes?

  82. Blake Larsen says:

    This is news to me – we have 6 properties and for the past 2 years used the 750 hrs across all three in a similar situation to above – FT working spouse, at-home spouse doing management as well, filing as Active not passive RE Pros. We first purchased and renovated them sequentially over a year’s time when there was no earned income and this was FT activity; then one spouse went back to work. They are all rented and we continue to self-manage, filing jointly and not as a business. I read 2010-13 and it says “two or more business activities” require an election to group. Is that really meant to signify two or more rental properties/homes, or rather two or more separate business functions or business entities? e.g. both owning rentals and running a FT business flipping homes, or owning rentals and operating as a licensed real estate salesperson, etc.

    “• Effect of failure to report: A taxpayer that is engaged in two or more trade or business activities (or rental activities) that fails to report whether the activities have been grouped as a single activity will have each trade or business activity (or rental activity) be treated as a separate activity for purposes of applying the passive activity loss and credit limitation rules of section 469. However, a timely disclosure will be deemed made by the taxpayer who has filed all affected income tax returns consistent with the claimed grouping of activities and makes the required disclosure on the income tax return for the year in which the failure to disclose is first discovered by the taxpayer. If the failure to disclose is first discovered by the IRS, the taxpayer must also have reasonable cause for not making the required disclosures. In addition, the Commissioner may regroup a taxpayer’s activities to prevent tax avoidance pursuant to Reg. section 1.469-4(f). Thus, Rev. Proc. 2010-13 provides alternative relief for untimely filing of the disclosures; relief for untimely disclosures under Reg. section 301.9100 (“9100 relief”) is not available. “

  83. Blake Larsen says:

    answered my own question by reading here http://www.irs.gov/publications/p925/ar02.html about passive vs active, RE Professional rules, and grouping, with lots of examples.

  84. Diane Kennedy says:

    Hope, it sounds like the IRS agent has the Real Estate Professional (REP) and the material participation rules confused.

    The REP requires 750 hours or more and more REP hours then any other business. Material Part requires 500 hours or more per property unless you make an aggregation election. Back in 2009, you could not make a retroactive aggregation election. Starting in 2010, you could. Unless you get them to allow you to make that late election, you may be stuck on this one.

  85. Diane Kennedy says:

    Gina,

    Real estate losses in California are tough because you can’t use the REP designation (as you know). Honestly, best bet is to start a business. You get the write-offs in CA at least!

  86. Diane Kennedy says:

    Blake, the grouping guidelines come from Rev Proc 2010-13, which became effective in 2010. Prior to that, we had to make timely aggregation elections on the return. The Rev Proc is a lot more friendly, allowing you to make elections retroactively.

  87. Gina says:

    Hi Diane,

    Thank you for your response. Just to clarify, when you say the ‘best bet is to start a business’, do you mean incorporate?

    Thanks again,
    Gina

  88. Lila says:

    Hi! We are in the midst of an IRS audit where we completely disagree with our auditor. We met with his supervisor tonight and she told us our only option is to appeal.

    I have read, re-read and read again and again multiple websites and articles related to the ‘real estate professional and material participation’ rules. Can you please help me distinguish this issue?

    I am a real estate professional. I’m a Qualifying Broker of my own company and have been for 10 years. This is my only source of income. I also jointly own 3 rental properties with my husband – 1 of which is in-state (NM) and the other 2 are out of state (AZ & ME). We are trying to understand and interpret the active vs. passive income/loss IRS code.

    Is the 750 test of qualifying as a real estate professional just that? I own & operate a residential real estate brokerage. I represent buyers and sellers buying and selling homes and land. I work 60-70 hrs/week at a minimum. Do these hours need to ‘include’ my own portfolio? We elected in 2007 (when we got married) to treat all of our properties as one activity. Do I need to spend a minimum of 750 hours JUST on my rental properties to qualify as a real estate professional? Or do my 750+ hours on my real estate brokerage and clients qualify me to pass that test?

    My understanding is that I can qualify as a real estate professional as being a Qualifying Broker and spending a minimum of 750 hours in the real estate trade. In addition to this, I must pass ONE of SEVEN tests in my personal rental properties to qualify them as active investments to recognize active income/losses.

    Am I incorrect here??? Our auditor’s supervisor told us that I must spend 750 hours of my real estate profession ON my own properties AND pass 1 of the 7 material participation tests. Why would I spend 750 hours + additional hours on my own properties to qualify? If my 750 hours were ‘material’ participation why would I then to need qualify for more hours per property or as a grouping of properties? I’m so confused and frustrated – we just want to get this right.

    Thank you.

  89. Diane Kennedy says:

    There are two tests for the Real Estate Professional deduction. (1) You have to be a real estate professional. It sounds like there is no question that you meet this requirement. (2) You must have material participation.

    Material participation is defined as 500 hours per property per year. If you make an aggregation election, then you need to only meet one 500 hour requirement.

    A couple of things to note here: You quoted ‘active’ participation which is different than ‘material.’ If you make less than $100K AGI, then you just have to meet the active participation standard. If you are a real estate professional and income is over $100K (which is why you’re taking that position) then you need 500 hours.

    The IRS ATG has a mistake in it, so your auditor may be misreading the requirement. The ATG is the audit handbook that the auditor is likely using. In the beginning narrative it states 500 hours for the material participation requirement. But in the checklist near the end of the ATG it says 750 hours. It should be 500 hours. If you can’t convince the supervisor of that, drop another note here and I’ll give the appropriate cites in tax law.

    The IRS had previously, incorrectly, taken the position that a real estate agent didn’t qualify as a real estate professional. They lost in tax court on that argument. LMK if they are making that false claim in your case.

    And finally, in the past the IRS did not allow taxpayers to retroactively aggregate properties so that you don’t have to meet the 500 hours per property requirement. They lost that argument just recently. They have to allow you to make that aggregation election.

    FINALLY: Talk to your CPA before you make the aggregation election. It can bite you if you later sell at a loss. You need to de-aggregate first.

  90. steve tsi says:

    hi diane, we got auditted 2 months ago. i own 3 rental properties in nyc. irs is claiming that i can’t deduct the 25,000 loss cause i have a full time job. my account just told me we should wait for the judgement. my questions are these

    we plan on appealing if they say i need to pay. can we make up logs for the years they are fighting me on?

    my wife is a stay at home mom. she goes for the rents, does the garbage, clean hallways, change bulbs etc, if she logs more than 750 hrs per year per property is she considered a real estate pro?

  91. Diane Kennedy says:

    The IRS will want to see that you have more hours in real estate activities than you do in your full time job. Either you or your spouse can qualify, but it sounds like it might be easier for your wife to qualify. In her case, she will need to prove that she spend 750 hours or more in real estate activities.

    It’s usually much better to deal with audit issues before they go to appeals. You can solve problems faster and way cheaper at that level. As you move up the chain, your accountant or attorney will need to be more involved and the cost to you goes up.

  92. Sol says:

    Hi Diane: I live in California. I am retired. I own multiple rental properties in Las Vegas. I spend more than 500 hours per year going back and forth to Vegas, researching, and buying single family homes. I oversee the rehabs and management using contractors and property managers. Do these activities qualify as material participation? Can I the use the expenses of travel, lodging, LLC formation to offset retirement income, or only real estate income? Please help.

  93. Rob says:

    Diane – can you elaborate on “real estate agent” now being a “real estate professional”? If you’re a licensed, active, full time agent (Realtor), but not a broker does that pass the first test?

    Secondly, I only own one single family home. I couldn’t find 500 hours if I tried. What does that mean in terms of writing off loses? The property is severely underwater so my losses are $6,000 per year.

  94. Diane Kennedy says:

    This is the blog entry that won’t die. It’s now in it’s 4th year…

    Sol, first thing to determine is if you qualify for the $25K offset. Your AGI would need to be $100K or less. If you’re retired, that may be the case, in which case the standard is much lower. You just need to prove active participation, which is 100 hours per year per property.

  95. Diane Kennedy says:

    Rob, about 5 years the IRS auditors started disallowing real estate agents from claiming real estate professional (REP) status. One of the allowed real estate activities is “brokering” a deal and their argument was that only a broker could broker a deal. They lost at least 3 Tax Court cases on that argument. (Might be more, I stopped counting) So, yes, a real estate agent’s hours do count as a real estate activities. Of course, you have to meet the 750 hour test in real estate activities, more hours in that then any other trade or business and you have to have your own business. In other words, you can’t be a W-2′d real estate agent.

    The second part of the test is 500 hours per property in material participation.

    If your income is over $150K, then you do need to pass both of those test.

  96. Debra says:

    Diane – Why does material participation have to be 500 hours? What about the other qualifications such as if you put in 100 hours but that is more than any once else?

  97. Gary says:

    I bought some vacant land as an investment about 6 years ago (paid cash). I have received no income from the vacant land, and my only expenses were only property taxes. I have one other rental property. Because of the market crash I was forced to sell the land at a $50K loss from the purchase price. I believe am classified as a “real estate professional” since I hold a real estate Broker’s license and own my own real estate brokerage company however, Even though I own the company and work full time trying to sell real estate I have not been very successful this year due to market conditions, and also do I need to show 500 hours actively managing the vacant land I held for investment properties (can’t really say I did anything since it was vacant land…). My spouse and I have total wages of about $20k this year, and we were planning on withdrawing 150k from our IRA to pay off our home mortgage and retire. Can I deduct the $50k loss on the vacant land purchase against the taxes I will owe this year?

  98. Sol says:

    Hi Diane. Thanks for your reply. I do NOT qualify for the 25K offset since my AGI is over $100K. So, what can use to offset passive income? What can I use to offest active income? How about my home office which I use for real estate reserach etc.? And what did you mean by “active participation”?

    Sopl

  99. susan taylor says:

    Diane…I am a w-2 salaried real esatate professional who also earns commission on top of my salary. I am a licensed broker in 3 states and own two resort properties that unfortunately have been upside down in the current economy. I am being audited for the first time in 31 years. Do you have any info for professionals such as myself who do work FULL TIME in REal Esate, always have. No other jobs, just happen to work for a company that pays me a salary plus commission? Help Audit is on right now.

  100. Chip says:

    Hope, Bruce and others made reference to REP activity hours that were not allowed in an audit.. “Collecting deposits/income, depositing deposits/income, cutting the grass, shoveling the snow, maintaining the premises, answering phones, checking the mail, drive-bys and tax preparation.’

    I saw a reference to IRS guidelines for activities that qualify for the REP designation? Do you know where I can find these guidelines from the IRS?

  101. Diane Kennedy says:

    Please go to http://www.DianesSeminars.com and sign up for the FREE webinar on Sat 3/9 regarding Real Estate Professional updates.

  102. Edward says:

    I am being audited for my real estate properties. I have 8 and manage 3 myself. The auditor told me that I should have elect to aggregate my properties. This is the first I heard of this and I have been claiming losses on my proterties. Is it to late to submit logs while being audited?

  103. Diane Kennedy says:

    Thank you for your question. I’ll be doing a blog post about this at http://www.USTaxAid.com in the near future. There are a lot of possible ramifications to making the aggregation election and it’s best to consider those before you jump.

  104. Janet says:

    Hi Diana – I realize by posting that I’m pulling this 2008 entry into 2014. ;) IRS Publication 925 says the following:

    “You materially participated in a trade or business activity for a tax year if you satisfy any of the following tests.

    2. Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who did not own any interest in the activity.
    …”

    My interpretation of number 2 above is that as long as nobody else is doing anything to manage the property, it doesn’t matter how many hours I spend. For example, I have 6 rental properties that I do in fact manage myself (screen tenants, write leases, do walk-throughs, do or oversee repairs, collect rents, manage books, etc.), but it just doesn’t add up to anything close to 500 hours even if I were to aggregate (which I haven’t done). There’s just not that much to do. But, because “[my] participation is substantially all the participation in the activity…” I’ve met the requirement, correct??

  105. Diane Kennedy says:

    Hi Janet: It’s actually kind of sad that so many people still are having trouble with the IRS on this subject, 6 years later!

    The ‘substantially’ all requirement does hold up for materially participating. However, make sure that you qualify for each property individually. That is the 3rd part of the test.

  106. Natalie says:

    Hi Diane,

    I am a majority owner in a two-person LLC that owns a condo out of state. My husband has a full time (non-real estate) job and I don’t. I have been deducting the losses as a real estate professional. We live in CA.

    1) According to the IRS: “no interest in a limited partnership as a limited partner shall be treated as an interest with respect to which a taxpayer materially participates.” Does this mean in order to deduct losses, we shouldn’t hold the condo in an LLC, but directly instead? What if I’m the manager of my LLC?

    2) If I am a manager of other LLCs, can I add the number of hours from those activities toward 750? Do I need to own 5% of those LLCs in order to this?

    3) Is there a list of what type of hours can be accepted in a log? Dealing with insurance company repairs/payments, looking for another property to buy, dealing with the building’s HOA mgmt company, hiring/dealing with contractors, paying bills. Do any of these qualify?

    4) IRS also says: “In determining whether a taxpayer materially participates, the participation of the spouse of the taxpayer shall be taken into account.” If we make a change where my husband is the majority owner of the LLC, could we still deduct the losses if I’m the only one putting in the 750hrs of work?

    Thank you for keeping this blog. It’s by far the best one!

  107. Diane Kennedy says:

    Thanks for the comments! This particular blog has been around for 6 years.
    (1) Yes! I recommend that you are listed as the manager of the LLC. If it isn’t already, you should have your LLC be manager-managed as opposed to member-managed.
    (2) As long as you are performing real estate activities, those hours can work for 750 hour test.
    (3) Check out page 2-5 of this: http://www.irs.gov/pub/irs-mssp/pal.pdf
    (4) Don’t confuse REP hours with material participation. They are two separate tests. REP is 750 and only one person. Material participation is per property and you can combine hours

  108. I am currently representing a client in an IRS audit and trying to prove the REP status for my client. He owns several (7-8) residential rental properties and one commercial property (rented to his retail business) that was demolished and rebuilt in the year in question. Most of the properties including the commercial property were transferred into his single member LLC in that year as well. We produced a time log showing 450 hours managing his retail business (which is mostly run by his son) and 941 hours managing the rentals and overseeing the new construction. Our issue is that our IRS auditor says the reconstruction time (about 450 hrs) cannot be combined with the day to day rental duties (about 491 hours). We are most likely going to appeals with this but I’m looking for something solid to hang my hat on.

What do you think?