Are You a Real Estate Professional?

By Billy Litz, CPA

With the passing of the Health Care and Education Reconciliation Act, which imposes an additional 3.8% tax on net investment income (exceeding certain amounts) starting in 2013, qualifying as a real estate professional has become even more important for certain taxpayers.

Real estate professionals may treat rental real estate activities in which they materially participate as nonpassive, and thus, not subject to the passive activity rules which limit losses, or the 3.8% tax on net investment income. To qualify as a real estate professional, a taxpayer (or their spouse) must meet the following tests:

  1. Participate in a real property trade or business (including development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage).
  2. Materially participate in that real property trade or business under one of the seven tests.
  3. More than one-half of the personal services you perform in all trades or businesses for the tax year must be performed in real property trades or businesses in which you materially participate.
  4. Perform more than 750 hours of services during the tax year in real property trades or businesses in which you materially participate.

If the 4 tests are met, a taxpayer is considered a real estate professional and may treat the rental activities in which he/she materially participates as nonpassive income or loss, not subject to the passive activity loss limitations or the 3.8% net investment income tax. If a taxpayer has multiple rental activities, he/she will need to assess in which activities he/she materially participates and treat them individually as passive or nonpassive accordingly or make an election to treat all rental activities as one.

By making an election to treat all rental activities as one, the taxpayer will measure his/her material participation by summing all of the hours spent on the multiple activities. This election will be effective for each future year and for all future years in which the taxpayer is a real estate professional.

The treatment of a taxpayer as a real estate professional has been heavily litigated and targeted by the IRS. To substantiate that you are truly a real estate professional you should keep logs of the hours spent on your duties and activities performed during the year. As always, should you have any questions, please consult your tax advisor.