There are many advantages of being a real estate professional for tax purposes. And, if you think you need a real estate license to be considered one, think again. The IRS allows you to claim real estate professional status if you meet certain requirements, allowing you to save at tax time.
Normally, if you make $100k or less in any given year, you are able to deduct up to 25k of real estate losses, which result when rental expenses exceed rental revenue. If you make between $100k and $150k, you can only deduct part of your losses.
Now, if you make above $150k, you are usually not allowed to offset any of the losses against your other income (i.e., your W-2 income). Instead, these passive losses are carried forward, indefinitely, to be offset against future rental gains, reported when rental revenue exceeds rental expenses.
If you are not considered a real estate professional, your rental activity is considered “passive” and any losses are therefore not allowed to be offset against non-passive income such as income earned from your job.
Advantages of qualifying as a real estate professional
There is a way around that, though, if you qualify as a real estate professional and the IRS will allow you to deduct your rental losses without limitation, even if you make above the $150k threshold.
So, who exactly is a real estate professional and how can you qualify?
Criteria to qualify as a real estate professional
A real estate professional is any person (or spouse) who meets the following two requirements set by the IRS. Both criteria must be met in order to qualify:
#1 More than 50% of the total working hours must be spent in real estate.
#2 A minimum of 750 hours per year must be spent in real estate activities.
Ideally, you must have record of the hours you worked during the year.
Understanding the concepts
Husband and wife own 2 rental properties, which Wife manages working a total of 750 hours per year. Husband earns $160k a year. They report rental losses of $35k, which they are able to fully offset against Husband’s W-2 income. They will pay taxes on $125k of earnings.
Husband and wife own 2 rental properties, which Wife manages, working a total of 500 hours per year. Husband earns $160k a year. They report rental losses of $35k a year, which they are unable to offset against Husband’s W-2 income because Wife did not meet the 750-hour requirement. They will pay taxes on the $160k earnings.
Mary is a single taxpayer who owns 3 properties. She works 40 hours a week as a project manager (2,000 hours per year). Additionally, she worked 750 hours in her real estate properties and reported $35k in rental losses. She cannot deduct the losses against her income because, even though she spent 750 hours in real estate activities, she did not work the additional 2,000 hours in real estate (50% of 4,000 is 2,000).
Qualifying as a real estate professional is a smart strategy to make sure you can offset your rental losses against your income, paying lower taxes at the end of the year.
So, make sure to consult with your tax advisor to find out if this is a strategy you can implement in your taxes this year.