If you are a real estate investor, you may have heard of real estate professional status, or REPS, and how it can help you reduce taxes on your rental income. In this article, we will explain what REPS is, and most importantly, how to qualify for it.
What Is Real Estate Professional Status?
Real estate professional status is a term that exists only in the tax world, as defined by the IRS. It has nothing to do with the degree you went to school for or which licenses you hold. In fact, just because you are licensed in real estate does not automatically mean you are eligible to be a real estate professional in the eyes of the IRS.
To qualify for REPS in the United States, you must meet two criteria:
- Material participation: You must materially participate in real estate activities. This means that you must be involved in the day-to-day operations of the properties you own or manage. The IRS provides a list of activities that count towards material participation, which includes advertising, collecting rent, overseeing repairs and maintenance, and negotiating leases.
- Time spent: You must spend more than 50% of your time and at least 750 hours during the tax year on real estate activities. This can include time spent managing properties, acquiring or disposing of properties, and researching or analyzing real estate investments.
It is important to note that not all real estate activities count towards real estate professional status. For example, simply owning rental property does not automatically make you qualify. You must be actively involved in the management of the property to qualify.
If you meet these criteria, you may be able to deduct losses from your real estate activities against your other income, subject to certain limitations and rules. However, it is important to consult with a tax professional to ensure that you are meeting all of the requirements and properly claiming your deductions.
What Are the Benefits of Real Estate Professional Status?
The main benefit of REPS is that it can help you avoid the passive activity loss rules that limit your ability to deduct your rental losses against your other income.
Normally, if you invest in rental real estate, you can always use expenses and depreciation to reduce your rental income. However, if you have more expenses than income, there are rules that determine whether or not you can use those excess losses to offset your other income, such as your W-2.
These excess losses are called passive losses and are carried forward for you to use to offset rental income or capital gains on the rental property in future years.
However, if you qualify for REPS, then you can treat your rental activities as non-passive activities and use your excess losses to offset any type of income without any limitations. This can save you thousands or even millions of dollars in taxes depending on your situation.
How Can to Qualify for Real Estate Professional Status
Qualifying for REPS is not easy and requires careful planning and documentation. Here are some tips to help you qualify:
- Keep track of your hours: You need to keep a detailed log of the hours you spend on your real estate activities throughout the year. You should record the date, time, description, and duration of each activity and keep supporting documents that serve as evidence of your involvement, such as receipts, invoices, contracts, emails, etc. You should avoid using estimates or round numbers as they may not be accepted by the IRS in case of an audit.
- Focus on quality over quantity: You need to show that you are performing substantial and meaningful tasks that affect the profitability of your real estate activities. You should avoid counting hours that are incidental or personal in nature, such as driving by your properties, reading magazines or books about real estate, attending seminars or webinars that are not directly related to your specific properties or business plan, etc. You should also avoid delegating tasks that demonstrate your material participation to others, such as contractors or property managers.
- Choose the right entity and structure: The type of entity and structure you choose for your real estate business can affect how you qualify for REPS. For example, if you own your properties through a corporation or a partnership (other than a husband-wife partnership), then you need to meet an additional test of owning at least 5% of the entity to count your hours toward REPS. If you own your properties through an LLC or an S corporation (or a husband-wife partnership), then you do not need to meet this test. However, if you own multiple properties through different entities, then you need to elect to aggregate them as one activity to count your hours toward REPS. That is why you should consult with a tax professional who can help you choose the best entity and structure for your situation.
- Work with your spouse: If you are married, you can combine your hours with your spouse’s hours to qualify for REPS. However, only one of you needs to meet the 50% test. The other spouse only needs to meet the 750-hour test. This can make it far easier for you to qualify for REPS if one of you has a full-time job outside of real estate.
We Can Help You Qualify
If you are interested in claiming REPS and reducing taxes on your rental income, you need professional guidance and assistance from experts who know the ins and outs of this complex strategy. That is where we come in.
At Quilca CPA Group, we specialize in real estate tax strategy and have extensive experience in helping Florida real estate investors navigate the complex process of becoming a real estate professional. If you are ready to take advantage of the tax benefits of REPS, do not hesitate to contact us today. We are eager to hear from you and help you with your real estate and tax needs. You can reach us by phone at (786) 310-5582 or by email at [email protected].
