Could you or your spouse qualify as a real estate professional, in the eyes of the IRS? Or maybe a better question is: Do you want to?
If you have real estate passive losses from long term rentals, you can only offset those losses against other income if:
- Your adjusted gross income is less than $100,000 and you have active participation, or
- Your AGI is from $100,000 – $150,000 and you have active participation.
In the case of $100,000 or less, you can take a deduction of up to $25,000. If your AGI is $100K – $150K, the amount you can deduct phases out.
If your AGI is over $150,000, you can’t deduct anything unless you or your spouse is a real estate professional. If you’re married, you have to file as married, filing jointly. You cannot file married, filing separately. And if you’re single, you have to be the one who qualifies.
And one more warning: This doesn’t work for every state. For example, California does not recognize the real estate professional status and so you might get a great deduction for federal purposes, but you can’t take it for your state return.
There are three tests for the real estate professional status:
1. You or your spouse must meet this one alone. You cannot combine hours. You need to have at least 750 hours of real estate activities and more hours in real estate activities than any other trade or business.
2. You and your spouse can combine your hours for this test. You must have material participation, defined as:
500 hours of material participation in the property,
100 hours of participation and more than any other person in regards to the property, or
More than everyone else combined
3. Each property must stand alone.
You have to meet each test. Those are the rules, but there are a lot of further details and strategies.
For example, what are real estate activities? Can you start a business to qualify? What do you do to qualify if you have more than one property? How can you use the easier standard for material participation?
And then, you have to make sure your tax return is properly prepared by an experienced CPA. Make a mistake and you’re just asking for an audit.
There is a lot to consider, but the fact that you can use the real estate professional status in conjunction with depreciation strategies and a cost segregation study to never pay tax again can make the extra work all worthwhile.