Written by: Ron W. Salmon, CPA
It is now more beneficial to be a “Real Estate Professional;” however, it has nothing to do with the state of the real estate market.
The term Real Estate Professional (REP) has been used since the late 1980’s to define whether a taxpayer’s real estate activity was active or passive. Prior to 2013, the significance of the designation was to determine if a real estate loss was deductible. For someone not classified as a Real Estate Professional the loss was deductible only to the extent the taxpayer had passive income. A real estate professional could deduct the loss regardless of passive income.
A significant change was recently made. Beginning in 2013, net passive income is subject to the new 3.8% Medicare tax. As a result, the real estate professional status prevents passive real estate income from being subject to the new 3.8% tax.
Tax regulations define the “Real Estate Professional” with the following stipulations:
- More than 50% of all services performed by the taxpayer during the year must be “real property trades or businesses” in which the taxpayer materially participates.
- Taxpayer performs more than 750 hours of services in “real property trades or businesses in which the taxpayer materially participates.
The Real Estate Professional status is further complicated by rental property. The final regulations for the 3.8% Medicare tax further defines rental property as it relates to real estate trades or businesses:
- A Real Estate Professional who participates in one or more rental activity for more than 500 hours.
- A Real Estate Professional who has participated in one or more rental real estate activities for more than 500 hours in any 5 tax years (whether or not consecutive) during the 10 tax years that immediately precede the taxable year.
The IRS regulations require a taxpayer to contemporaneously maintain a log of their rental real estate activities. Examples of rental real estate activities include but are not limited to:
- Supervising building maintenance
- Handling advertising
- Showing vacant property
- Handling all leasing related activities
- Collecting rents
- Performing various administrative activities
There is every indication that the IRS will continue to closely monitor real estate professionals. Although the benefits of being a Real Estate Professional are substantial, it is extremely important to properly document your real estate activities for tax purposes. If you have any questions, please feel free to contact us.