Qualifying as a real estate professional under IRS rules removes the $25,000 cap on passive losses and lets you use depreciation losses fully. You need to spend more than 50% of your work hours on real estate and at least 750 hours per year. One client recovered $150,000 in suspended losses after hitting these thresholds.
The blanket rule as to why real estate professional status is important, it's not a do-or-die type of thing. It's not a make-or-break it, but for those who can qualify, it's really good that you do because without it, if I have passive activities and that passive activity generates a loss, for example, I have a rental property and with my depreciation, I actually generate a net tax loss. Because depreciation is a tax deduction, but it doesn't actually take my cash. If I have a net loss, I can take up to $25,000 of a passive loss depending on my income level, but nothing more than that. So if I have properties that generate collectively a $50,000 loss, I can only offset that loss to the extent that I have passive income. And that's as a non-real estate professional. So that's why it's important if you can qualify for this status that you do. I'm going to walk you through how the IRS qualifies a real estate professional. But if you don't, then you want to talk to your specific accountant. We might need to do some stuff within your tax strategy to make sure that you can benefit from all your passive losses. Because right now, if you don't do anything, it's what they call suspended, and it'll carry on to your tax return until you have passive income to offset it. As an example, I had a client, when I picked them up, they had about $300,000 of suspended loss. That equates to, for them, $150,000 in taxes that they paid because they couldn't take that $3,000 loss. With some easy tweaking, we were able to fix the things for them, and they then saved $150 grand in taxes by being able to capture that loss. So this is really important. Also, if you qualify as a real estate professional, you avoid what they call the net investment income tax. So that's if like you sold a property without this status, you are gonna pay this additional tax. You avoid having to pay that with this status. So how do you actually qualify? More than 50% of your services have to be performed in the real estate space. That means if I have a full-time job, which most of the time they calculate at say 2,000 hours, they just round down. Yeah. I would need to spend another 2,000 hours in real estate for 50% of my services to be considered real estate because they're going to look at all your activities. They add that number up, half of it needs to be in real estate. So if I have a full-time job and maybe I have a spouse who doesn't, we're probably going to look to get my spouse qualified as a real estate professional because all of the spouse's services can be contributed to real estate. So 100% would be contributed to real estate. They do have a minimum number, which is 750 hours need to be performed in real estate. It's a little bit less than 20 hours a week. So you would have to be able to document That more than 750 hours were spent on real estate services. But it has to be both of those. This is what they call an and qualification. More than 50% of services and more than 750 hours. So I could have a full-time job. I could be spending 750 hours in real estate, but that 750 is only going to be 25% of my total time. The whole materially participating in each rental activity, honestly, if you qualify for 50% and 750, It's very hard to argue against that you are materially participating in each rental activity, but it is technically a 3rd criteria. So I just wanted to make you aware of it. But really the 2 big hurdles are the 50% of your services and 750 hours. So what does qualify when it comes to services in the real estate space? As you can see, we kind of gave you a list. It's spending time doing developments, redevelopments, construction, rehabbing, acquisitions, rentals, operations, management, leasing, and education. So anytime you spend trying to improve yourself, going to seminars, watching videos from packages that you've purchased, spending time in the community of the real estate organization that you might be affiliated with, all of those hours count. And again, if you're audited, you have to show documentation that you spent the 750 hours on real estate qualified services. As long as you can prove that you have those hours, then you would qualify. So just to recap this video, entity selection is really important based on the distinction of passive income versus active income. Hopefully this helps. If you need any sort of tweaks based on what you just learned in this video, please contact your direct professional. And in case anyone is ever on Jeopardy, the answer is the IRS sucks.
