How to Qualify As A Real Estate Professional (As a Doctor)
One of the best ways to avoid taxes and build true wealth is to qualify as a real estate professional (REP).
Here’s a video walkthrough of what that looks like:
With REP status, you can offset some of your business/practice income with deductions associated with actively managing rental properties, thus reducing your tax obligations.
Attaining this status involves several misconceptions. I encourage you to work with a group to ensure you’re documenting the process properly. If you don’t have a CPA who can handle this, feel free to contact mine HERE.
Let’s get started….
Join the Passive Investors CircleWhat Is Real Estate Professional Status?
Real Estate Professional Status is a tax classification that can yield significant tax savings for those heavily involved in the real estate industry. REPS allows you to treat rental real estate activities as non-passive, enabling you to deduct losses against non-passive income.
IRS Requirements for Qualification
The IRS has clear criteria that you must meet to claim REPS:
- More than half of the personal services you performed in all trades or businesses during the tax year must be in real property trades or businesses in which you materially participated.
- You must spend at least 750 hours during the tax year in real property trades or businesses in which you materially participate.
If you are married, you or your spouse must meet both requirements individually without combining hours.
How to Qualify as a Real Estate Professional
Personal Services
Personal services entail any work you perform personally in real property trades or businesses, including development, redevelopment, construction, reconstruction, acquisition, conversion, rental operations, management, leasing, or brokerage services.
Business Activities
Business activities should be approached diligently. You must materially participate in the real estate businesses, meaning you are regularly, continuously, and substantially involved in operations.
*Passive investing does NOT qualify, which is confusing when attempting to obtain this status, especially from doctors and dentists.
|
Criteria |
Requirement for REPS Qualification |
|
Personal Services Proportion |
>50% of personal services in real property trades or businesses |
|
Hours of Participation |
≥750 hours per tax year |
|
Material Participation |
Regular, continuous, and substantial involvement |
|
Type of Services |
Development, management, leasing, etc. |
750-Hour Requirement
You must complete at least 750 hours of services related to real estate trades or businesses each year. This must be more than what you spend on non-real estate activities and substantial enough to satisfy IRS criteria.
- Key Points:
- Your hours must be over 50% of your total professional service hours for the year.
- The 750 hours must pertain to the real property trades or businesses where you’re striving to claim real estate professional status.
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Sign up for my newsletterMaterial Participation Test
The Material Participation Test scrutinizes your involvement in real estate endeavors, ensuring regular, continuous, and substantial engagement.
| Determining Factors for Active Participation | Description |
|---|---|
| Work Performed Personally | The extent of the work you personally perform in the activity. |
| Participation Over 100 Hours | Your participation exceeds 100 hours and is as much or more than any other individual involved. |
| Substantial Participation | Consistent and substantial participation throughout the tax year. |
Real Property Trade or Business
To qualify, your real property trade or business activities must be substantial. These include but are not limited to:
- Development or redevelopment
- Construction or reconstruction
- Acquisition or conversion
- Rental
- Management or operation
- Leasing
Importantly, over half of the personal services you perform in all trades or businesses during the tax year must be in real property trades or businesses in which you materially participate.
Documenting Hours of Service
Keeping detailed records is vital for substantiating your claims of professional status. When documenting your hours of service, employ a method that is considered a reasonable means of proof.
| Documentation Guidelines | Description |
|---|---|
| Contemporaneous | Should be compiled as the hours are worked to ensure accuracy. |
| Include Specifics | Document the nature of the work, dates, and hours spent on each activity. |
| Reliable Tracking Methods | Use calendars, time reports, or logs, supported by additional evidence like emails or invoices. |
Grouping Election for Activities
The grouping election allows you to treat multiple activities as a single activity to determine material participation. By making a grouping election under IRC Section 469(c)(7), you can:
- Combine the hours spent on different but related real estate activities to meet the 750-hour requirement.
- Ensure that your time commitment represents a significant time investment across your grouped activities—a crucial aspect for validating your status as a real estate professional.
Remember that grouping is an important strategic decision that can affect your ability to demonstrate that you meet the hours requirement for qualifying purposes. It must be made with careful consideration of your involvement in each of your real estate activities.
Tax Implications and Benefits
Understanding the tax implications and benefits of qualifying as a real estate professional can significantly impact your taxable income and offer valuable deductions. Your status affects how you navigate passive activity loss rules and the potential to offset other forms of income, reducing your overall tax liability.
Passive Activity Loss Rules
Passive activity loss rules define how losses from passive activities can be used to offset other income. As a real estate professional, you may bypass some of these rules, which generally prevent the deduction of passive losses against non-passive income.
Remember, you must ensure that more than half of your personal services are in real property trades or businesses, and you must materially participate in these activities.
Real Estate Professional Deductions
Real estate professionals can leverage tax deductions, often including a wide range of expenses associated with income generation. These might encompass mortgage interest, rental property taxes, operating expenses, depreciation, and repairs.
You are allowed to deduct real estate losses from your other sources of income, including wages, business income, or capital gains.
This can lower the overall amount of taxable income and possibly the Net Investment Income Tax they are obligated to pay.
Imagine what it would be like to pay $0 in taxes. It’s a game-changer.
Future Years Considerations
Looking ahead to future years, maintaining your status as a real estate professional can yield ongoing tax advantages.
It’s important to plan for the future by understanding the limitations of passive activity loss that carry over to subsequent years if you can’t utilize them in the current year.
This carryover can potentially offset future gains or income, making long-term tax planning a crucial aspect of your real estate investment strategy.
Keep precise records of your involvement in real estate activities to continue meeting IRS requirements for this beneficial tax status.
Navigating IRS Audits
IRS Audits can be daunting as the IRS will potentially scrutinize the validity of your real estate professional status. You must meet specific criteria to qualify, which can result in disqualification and additional taxes.
- Record-Keeping: Maintain detailed logs of hours spent on real estate activities.
- Proof of Participation: You need to prove more than 50% of your work time is spent on real estate businesses where you materially participate.
- Misunderstood Requirements: Simply owning property or spending time on real estate activities doesn’t automatically qualify you; the significance of your participation matters.
Related video:
Frequently Asked Questions
What are the IRS guidelines for determining if someone is a real estate professional?
You must provide more than half of your personal services in real property businesses in which you materially participate and work more than 750 hours in these businesses during the tax year.
What types of activities are considered in achieving real estate professional status?
The IRS considers activities such as development, redevelopment, construction, and reconstruction. They also include acquisition, conversion, rental, operation, management, leasing, or brokerage services.
How can I become a real estate professional if I already have a full-time job?
If you have a full-time job but are interested in becoming a real estate professional, you can start by investing in real estate on the side. Many real estate investors begin by purchasing properties to generate rental income. However, be aware that rental losses can also occur, and managing properties can become time-consuming. Hiring a property manager can help alleviate some of the workload, allowing you to focus on your full-time job while still growing your real estate investments. Gradually, you can expand your knowledge and experience in real estate by exploring areas such as real property development. As you gain more expertise and if your situation allows, you might consider transitioning to a career as a real estate agent or a full-time real estate investor. Keep in mind that for tax purposes, the IRS has specific guidelines on what constitutes a real estate professional, so it’s essential to consult with a tax advisor to understand how this could impact your professional tax status.
Can being a landlord qualify you for real estate professional status with the IRS?
Yes, if you are actively involved in rental activities and meet the specific time and participation requirements set by the IRS, you can qualify as a real estate professional.
What are the tax advantages of qualifying as a real estate professional?
Qualification as a real estate professional enables you to deduct real estate losses without the passive activity loss limitations. It can have significant impacts on reducing your taxable income.
What is the necessary level of ownership interest to be considered a real estate professional?
There is no specific ownership level required by the IRS for real estate professional status. However, you must materially participate in the operation of the real property business.
How does real estate professional status impact one’s tax filing and deductions?
Real estate professional status allows you to categorize income and losses from rental properties as non-passive. This can lead to more favorable tax deductions against your ordinary income.
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