There are four (simplified) steps to qualify as a real estate professional.
Number one: Identify the owner’s real property trades or businesses in which he or she materially participates.
Number two: The owner or investor must spend at least 750 hours a year on their rental properties. This could be repairs, bookkeeping, travel to and from, managing the property, etc.
Number three: If the owner or investor has another source of income, and spends time performing services to generate that other form of income, the investor must spend at least as much time on his real estate activities as he does his other business. If this is not a real property trade or business, the rental properties would generally be passive. If it is a real property trade or business, the rental activities MAY be non-passive.
Number four: The owner or investor must materially participate in every single rental property. There is an option to aggregate all the rental properties into one so that the owner or investor only has to participate in all of the rentals together materially, not each one individually. However, a statement must be sent to the IRS with the taxpayer’s tax return stating that the taxpayer is a real estate professional and meets the criteria.
Materially participates means:
- They participated in the activity for more than 500 hours during the tax year.
- Their participation in the activity for the tax year was substantially all the participation in the activity of all individuals for the tax year.
- They participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other person for the tax year.
- They materially participated in the activity for any five of the prior 10 tax years.
The designation of a real estate professional is very complex and misunderstood by many tax professionals. Please be very careful when choosing to designate a taxpayer as a real estate professional.
By: Kevin Jerry, Executive Vice President