There are significant tax benefits for investors who can qualify with the IRS for real estate professional status.
This is a great tax planning strategy that is particularly beneficial when you have multiple rental properties and have an adjusted gross income below $150,000. When your income is $100,000 or less per year, you can take a real estate loss of $25,000 per year against other income. If you make over $150,000, you can’t take any real estate loss. And, if you make somewhere between $100,000 and $150,000, the amount of allowed loss phases out.
If you can qualify for this designation, then you can take an unlimited amount of real estate paper loss against your other income, no matter how much you make or how much the real estate loss is.
There are three categories the IRS uses to classify real estate investors, each having different pros and cons. The first classification is a passive investor which is the least beneficial category and only allows a taxpayer the ability to deduct passive losses against passive gains.
The second classification is that of an active investor. This designation allows a taxpayer to deduct an additional $25,000 of losses against ordinary income, however, this deduction phases out completely at the Adjusted Gross Income (AGI) level of $150,000 for a married couple filing jointly and $100,000 for a single individual.
The third real estate professional classification allows taxpayers to deduct 100% of all real estate losses against ordinary income.
Many clients making this special election on their tax return, and who also have several rental properties, can create thousands of dollars in tax deductions resulting in a zero tax liability at the end of the year.
To qualify as a ‘Professional’ for tax purposes, a taxpayer, or their spouse, must meet a two-part test; the taxpayer must spend the majority of his or her time in real property businesses and the taxpayer must spend 750 hours or more in the real property business and rentals in which her or she materially participates.
The most common question we receive from clients is what activities qualify as real property businesses. The IRS does not statutorily list which jobs qualify creating ambiguity around this consideration which should be discussed with your CPA.
Taxpayers must also materially participate in the management of the properties. Taxpayers can qualify for material participation under 7 different categories. A qualified real estate activity is anything in which you “develop, redevelop, construct, reconstruct, acquire, convert, rent, operate, manage, lease, or sell” real estate.
Taxpayers must perform services in these activities, but you do not necessarily must be the individual performing the work. You can be supervising, meeting and planning the work since all the activities are included in running a business. This is another consideration that should be discussed with a financial expert.
There are drawbacks to incorporating the real estate professional status into your tax planning strategy which must be considered. Taxpayers who are classified as a real estate professional will have business income treated as ordinary income subject to self-employment tax. Establishing an S-Corporation is generally a necessary measure for an effective tax strategy incorporating the real estate professional status.
Reach out to our team regarding any questions about the Real Estate Professional Status or establishing a first-rate comprehensive tax strategy. We can provide real estate professional tax help in Charlotte and the surrounding areas. For more information about our tax services, please do not hesitate to give us a call at your earliest convenience. One of our friendly and knowledgeable representatives will be happy to answer any questions that you may have.