The Real Estate Professional Tax Loophole

This post is in: Blog, Real Estate

I met with a new client last week. As I reviewed their tax information before the appointment, I realized I was going to have a tough conversation with them. Tax rates have gone up, they’ve lost their tax exemptions, most of their itemized deductions and they were going to get slammed by the marriage penalty tax. That’s because both of them worked.

I didn’t want to tell them to get a divorce to pay less tax. But the fact was, that would have saved them on taxes. And that’s why they wanted the appointment with me. They wanted to know how to pay less tax.

Good news! They didn’t have to get a divorce. In fact, during the call we came up with a solution that’s going to work for them and will save them tens of thousands of dollars in tax.

It turns out that the husband worked long hours, but his wife only worked a day a week. They had some real estate and had already begun construction on a large commercial development. They would rent out medical professional offices. In other words, they were about to have a lot of real estate.

Real estate investment is about the only investment that lets you put money in your pocket and still create a tax loss. That’s because of depreciation. And with an expert who knows how to guide you with a cost segregation study, you can front-end load up depreciation. That means you can have big tax losses to offset other income and still be able to put money in your pocket.

But, there is a catch. If you make under $100,000 per year and are actively involved with the property, you can deduct up to $25,000 of your losses. Over $150,000 and you can’t deduct a penny. In between $100K and $150K, the amount you can deduct phases out.

So the great real estate tax deduction doesn’t work if you make too much money. That is, unless you are a real estate professional.

There are three steps you must complete in order to be a real estate professional:

  1. Either you or your spouse must qualify for the real estate professional (REP) hours. These are 750 hours or more per year and more hours in real estate activity than any other business.

    That’s why the wife quit her job. She needed to make sure she had more real estate hours. Of course, it is possible that she could have kept her part-time job and get the hours, as long as she had more real estate hours.

    Some more things to consider: What is a real estate hour? What activities qualify and how do you track them?

  2. You and/your spouse must materially participate in the property. In this case, both you and your spouse can combine your hours. You can’t combine for the real estate professional hours above, though. There are 7 different ways to qualify for material participation. One of those is having 500 hours per property. If you and your spouse spend 500 hours related to that property, you qualify.
  3. Each property must qualify, individually. If you are going for the 500 hours of material participation and you have 10 properties that means you’ll have to spend 5,000 hours on the properties! You can make an election to aggregate your houses so you then only need to pass one material participation test. There is a downside, though, if you make the aggregation election, you could have a problem when you sell a problem with a loss. Normally, you can take that loss against your other income. If you’ve had an aggregation, you’ll have to wait until you sell other properties in the group.

There is a reason that the wealthiest people in the US have either made their money in real estate or hold their wealth in the US. You can build wealth three ways: cash flow from the property, appreciation of the property and the huge tax breaks. When it comes to tax breaks, we can help.

If you’ve ever thought that having a Real Estate Accountant with you would be a good idea as you evaluate, buy and run a property, than you’ll want to check out Real Estate Accountant in a Box. Set up the right business structure, establish a powerful tax saving, wealth building strategy, find all of your hidden business deductions, file tax returns under the radar and not just survive an IRS audit, but totally destroy any chance of tax problems now or in the future.


  1. Diane Kennedy says:

    Hi Nora,

    Thank you for your comments! Besides studying the IRS Code and Tax Court cases, I also stay current on the current IRS audit practices. That plus a whole lot of real estate investor clients keeps me current. The article referenced was actually written several years ago. You can keep current with this blog and our coaching program.

  2. Nora says:

    Good Afternoon,

    I have been researching Real Estate Professional Activities based on IRS publications and regulations and have not found anything as extensive and outlined as your article from
    Where did you retrieve your information? Especially with regards to the following: “Remember that the key is that you perform personal services in these activities, but you don’t necessarily have to be the one performing the work. You can be supervising, meeting, planning–all of the activities that go into truly running a business,” and “Acquiring a property has many phases–meeting with sales people, looking at a whole range of properties, preparing an offering, responding to counter-offers, arranging financing, meeting with insurance agents, inspections, and actually closing a property. You don’t need to acquire a property to rack up a lot of hours in this area.”
    I would greatly appreciate if you could link your references or refer me to the books/publications/regulations/etc.

    Thank you so much for your time and patience.

    Happy Holidays!

  3. Diane Kennedy says:

    Yes, if you have a Solo 401 (k). Also, if you’ve rolled your 401(k) money into a rollover IRA. Otherwise, a group 401(k) plan won’t allow you to invest in real estate.

  4. Kay says:

    Can one buy real estate w/pre tax dollars from 401k?

Leave a Comment