Real estate professionals have benefited from one of the most epic housing markets in recent history. Not only that, but they also get handsomely rewarded on their tax returns too.
High-income earning professionals, not necessarily real estate agents, face a big challenge. Those individuals are about to pay a hefty tax bill as they get phased out of just about every credit and deduction. First-world problems, yes, but nobody likes to pay more taxes than they have to.
Real estate agents and professionals get the luxury of using real estate related expenses to offset their professional income. Everyone else is allowed to use expenses and depreciation on real estate activities to offset their real estate income, but not their employment income.
As an example, let’s say my wife and I own a rental property in Salt Lake City (and we do…). That property cost us $12,000 in maintenance and improvements in 2020. In addition, we had $18,000 in mortgage interest paid and $9000 in depreciation. That gives us $39,000 in rental real estate expenses. The rental income we received is $24,000.
The $39,000 in expenses can offset my rental income. This is true of any taxpayer.
But, a qualifying real estate professional can now use that $15,000 and offset our household employment income. A normal taxpayer would have to carry-over the $15,000 loss only to offset future rental income. Because my wife qualifies as a real estate agent, those losses can reduce our taxable employment income.
You follow me?
The tax savings from this preferential IRS tax treatment is a huge benefit! So now you might be asking, what does this do for me if I’m not a real estate agent??
Glad you asked. Well, you don’t have to be a licensed real estate agent to qualify for this tax benefit. In fact, there is no language from the IRS that states you need be to Realtor® at all. The IRS just speaks to 2 necessary requirements:
750 Hour Requirement
The IRS sets a requirement that you must be involved in real property trade for at least 750 hours during the course of that calendar year. That may seem like that would require you to be a real estate agent, but it covers a wide range of individuals. You can think of developers, construction, anyone involved in the acquisition of properties, rental management, rental operations, or brokerage trade.
If you own rental property, you move have spent 750 total hours over the course of a calendar year on maintenance, tenant placement, remodel, or operating the unit. This is especially true if you are operating an Airbnb, for instance.
You might be thinking you are on your way to real estate professional status, but there is another requirement to this rule. In addition, you have to have worked more hours doing one of the real estate related jobs previously listed than any other job. This one is a bit trickier, but not an impossible hurdle. For instance, perhaps you have a spouse who works part-time or flexible hours where that spouse could have worked more hours on real estate investments, than his or her other job.
If you are using rental properties to qualify for the 750 hour requirement, you must show the IRS that you materially participate in those same rental properties. Material participation really just means you would have to been involved in the operations of that property substantially- or specifically at least 500 hours of the 750 hour requirement.
In the example of my wife and I, we couldn’t say that because I did some financial planning for the Salt Lake City rental house and monitored for any parties, that we materially participated. We would have to spent some time over the year maintaining the property, placing tenants, and managing the rental.
Of course, you should document your time, purpose and dates throughout the year for IRS requirements. As you can see, it is possible to receive favorable real estate professional status even though you are not a real estate agent. Those saved tax dollars can go towards a more effective investment.
Talk to your CERTIFIED FINANCIAL PLANNER™ and accountant to see if you might qualify as a real estate professional. If you don’t have a financial planner, you can connect with me and I can guide you in the right direction.
Asset allocation does not ensure a profit or protect against a loss
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
Investments in real estate may be subject to a higher degree of market risk because of concentration in a specific industry, sector or geographical sector. Other risks can include, but are not limited to declines in the value of real estate, potential liquidity, risks related to general and economic conditions, stage of development, and defaults by borrower.