The Tax Advantages Of Being A Real Estate Professional

Prior to 1987, there was no need to differentiate between a 'real estate professional' and a 'passive real estate investor' for tax purposes. Up until this time in the United States, any losses incurred in a real estate activity could be used to offset other income earned by a taxpayer. This ability to shelter other income from taxes was a major advantage that attracted many investors to real estate.

However, the Tax Reform Act of 1986 changed all of that. The government at the time felt that there was too much tax shelter abuse going on, and through this act introduced a new concept called 'passive activities' to combat the abuse. Basically, most real estate investment transactions are now considered passive activities for tax purposes, and the income they earn is considered passive income. What this means to the average person who invests in real estate is that losses from real estate activities can only offset income earned from real estate activities or other passive income.

And this was the way it was until the "Revenue Reconciliation Act of 1993" was passed. Congress buckled somewhat to pressures from the real estate industry in passing this act, and in it came up with a designation called "real estate professional". According to the IRS, a professional is an individual who materially participates in real estate activities and thus is not limited by passive activity rules.

And therein lies the tax advantage that a professional investor has over a passive investor. A professional can deduct all of the losses from his/her real estate activities against any and all of their non-passive income.

Requirements You Must Meet In Order To Qualify As A Real Estate Professional:

You must meet both of the following requirements in order to qualify...

1. During the tax year, more than 50% of all the personal services that you undertook in all businesses and trades, were performed in real estate businesses and trades, in which you materially participated.

2. With respect to real property businesses or trades that you materially participated in during a tax year, you must have performed more than 750 hours of services.

To further understand these requirements you should know the following:

If you were an employee in real property businesses or trades, the services you performed as an employee cannot be counted with respect to the above requirements. And in order not to be considered an employee, you must have owned at least 5% of your employer.

A real property business or trade does any of the following with real property:

  • acquisition
  • brokers real estate transactions
  • development or re-development
  • leases or rents it out
  • construction or reconstruction
  • real estate conversion (ex. condo conversion)
  • manages or operates it

And finally, in general terms, you are considered to have materially participated in a real estate investment activity if you were continuously, regularly and substantially involved in its operation during the tax year in question.

If you (or preferably your professional accountant) determine that you are, for tax purposes, a real estate professional, you must fill in line 43 of Schedule E, Form 1040.

Return from Real Estate Professional to Real Estate Tax

Return from Real Estate Professional to Apartment Building Real Estate Investment For The Rest Of Us home page