How to qualify as a real estate professional in 3 easy steps

did you know that real estate has phantom losses these phantom losses can reduce your tax liability tremendously it's not a real loss now because of that very reason the irs looks very closely at these deductions the primary way that this is done is as a real estate professional an rep that's the way you're going to find out a lot of the rich people people who own a lot of property they pay zero taxes in this video i'm going to show you in three easy steps how to qualify as a real estate professional if you stay towards the end there's going to be a bonus i'm going to teach you a way a very amazing way that i just found out about where you do not actually have to be a real estate professional and still can deduct these phantom losses from your non-passive income if this sounds interesting to you please smash that like button comment on this and please share it with your network as well so other people can benefit my name is michael wander and i'm the founder of wander cpa for over 10 years i've been helping people invest save money on taxes particularly in the real estate industry let me mention that there are three ways and only three ways besides my secret that i'm going to tell you at the end how to deduct these quote passive losses from your non-passive income the first way is on the entire disposition of a asset in a fully taxable transaction the second way is that anybody may deduct up to 25 000 from as long as from their non-passive activity non-passive gains as long as their maggie modified adjusted gross income is below 100 000 it's reduced by 50 cents for every dollar above that so at 150 000 they do not have any deduction at all from their passive losses and the third way is to qualify qualify as a real estate professional which is what this video is about that is just to let you know that there are a few other ways but we are focusing on one specific way over here so just as a reminder if you did not do it already please smash that like button share this and comment if you feel somebody else can benefit from it the only way the only benefit the only compensation that i get from creating a video like this is by knowing that it's helping somebody so if you if so if this is helping you at all please do me a favor hit that like button let me know in the comments and share it as well thank you very much and with that let's delve right in so what are those three steps that are required in order to qualify as a real estate professional and be able to deduct your rental real estate phantom losses from your non-passive income those three steps are as follows i'm going to list them out and then we're going to go into detail defining the terms there and explaining them the first step is that you must have 750 hours annually spent in a real property trade or business in which you materially participate second step is you must have the majority that's 50 or or more of the time you spend throughout the year on real property trade or business in which you materially participate and lastly the third step is that each individual each single one of your rental activities must have material participation inside of it okay before we delve into the details it's going to be helpful to understand a brief history of passive activity losses prior to 1986 all income passive or non was considered equal in 1986 congress passed section 469 section 469 defines passive activities as follows any trade or business in which the taxpayer does not materially participate and any rental activity so as you can see those two key items any rental activity irrespective of material participation and any business in which the taxpayer does not materially participate are going to be considered passive activities and subject to the passive activity rules now an unintended consequence of this rule that's irc rule 469 was that a real true bona fide real estate professional was unable to deduct their passive losses excuse me their real estate rental activity losses from losses from gains they had in other aspects of their business for example a builder who kept a few properties for rentals they were not able to deduct those losses from the rentals against the gains they had from the sale now that did not seem fair so what congress did is they passed in 1994 section 469 c7 which says and i quote the committee considers it unfair that a person who performs personal services in a real estate trade or business in which he materially participates may not offset losses from rental real estate activities against income from non-real estate activities or against other types of income such as portfolio investment income in short they saw it was unfair and so they changed the rules now that's when the real estate professional status qualification comes in so it's important to realize recognize that the intent of congress was to provide a method a way for a real estate professional to deduct their rental real estate losses now it's turned into an attractive way for people to see if they could qualify see if they do qualify as a real estate professional so step number one in qualifying as a real estate professional is you have to have 750 annual hours in which you materially participate in a real property trade or business what is material participation there are seven tests and you must meet at least one of them seven tests are the individual participates in the activity for more than 500 hours during the year which is about 42 hours per month second one individuals participation in the activity for the taxable year constitutes substantially all of the participation in such activity of all individuals for the for such a year right so the individual's participation con constitute constitutes substantially all of the participation of all individuals for such a year that could be one that is beneficial for myself and for some clients number three the individual participates in the activity for more than 100 hours during the taxable year and such individuals participation in the activity for the taxable year is not less than the participation in the activity of any other individual including non-owners for such a year so the second the third one is that the activity has to be for more than 100 hours and it's not less than the participation of any other individual okay so two and three seem to be kind of similar have a little bit of overlap over there except number three has that 100 hour threshold but i'm sure there's some some there's some specific details over there that uh would have to be looked at number four the activity is a significant participation activity that's a legal term a tax term significant participation so pay attention and that is something we will discuss a little bit later not with respect to material participation as we're doing right now but with respect to the bonus at the end so number four again is the activity is a significant participation activity for the taxable year and the individuals aggregate participation in all significant participation activities during such year exceeds 500 hours so regarding significant participation exceeding 500 hours number five the individual materially participated and participated in the activity for any five taxable years seems a little bit kind of circular we're saying material participation is an event is you have to materially participate in the activity for any five taxable years but okay during the ten taxable years that immediately precede the taxable year six the activity is a personal service activity and the individual materially participated and participated in the activity for any three taxable years even non-consecutive preceding the taxable year and lastly seven based on all the facts and circumstances the individual participates in the activity on a regular continuous and substantial basis during such year so a few more things about material participation i know that was a lot a lot of jargon but a few more things is that really they define it the irs defines it as any work that you do in connection with an activity in which you own an interest meaning an interest so if you are an employee performing tasks that would generally fall under material participation you do not you do not you are not able to count those hours for your material for your real estate professional status hours unless you are at least a five percent owner of the business in which you are an employee got it so you have to own the business in order to use those hours for your real estate professional hours and lastly significant and continuous participation that's basically the intent always keep that in mind the intent of the irs when they created these rules now next definition second definition okay just one more bear with me is the real property right so again you have a real property trade or business that's also specifically defined there are 11 examples that are given and they're go they are as follows there's development real property development redevelopment construction reconstruction acquisition conversion rentals operation management leasing and brokerage those are the 11 11 examples that are given we're not going to go into detail about what each of those uh need to be what different activities within that qualified don't qualify that would be for a different time that would be for a different video but that is basically the definition of real property trade or business and that is the definition of material participation so again in summary step number one to qualify for a real estate professional is that you have to have 700 700 annual hours in a real property trader business as we defined it in which the taxpayer materially participates so that is tip number one again if you haven't done it yet please smash that like button share this comment do that and oh another another comment another note a spouse can a spouse qualify for the material participation or for the real estate professional status now it's interesting they one individual one of the spouses needs to have the full 750 hours they need to qualify as a real estate professional however as far as the material participation qualification goes the spouse a spouse is able to they are able to to use you are able to use your spouse's time spent on a rental real estate activity if it was material if it was material participation you can count the real estate professional can count those hours can't count that the hours spent by the other spouse as a to qualify that property as a material participation property let me say that one more time a real estate professional spouse can count the hours spent by their spouse their non-real estate professional spouse those hours spent on a real estate rental in which that spouse materially participated to qualify that property as a material participation property to include that property and deduct those losses from the non-passive income i know that's a lot listen to it again if you need to so there we go now we are going to jump on to step number two step number two is that the majority of all the taxpayers hours personal service hours have to be spent in a real property trade or business in which they materially participate so for example a full-time employee who's working 40 hours a week not in the job that they own not in the business they own would have to work an additional 41 hours on real property trade or business and materially participate that's a total of 81 hours per week which you can see makes it very difficult if not impossible for somebody with a full-time job to qualify as a real estate professional if somebody for example worked 20 hours per week they would only have to work 21 hours on a real property trade or business keeping in mind if you have a seasonal job such as teachers that the irs does consider prep time so a teacher could not just say my hours are 20 hours per week in class and then the rest of my time is spent preparing for or on a real real property trade or business without showing that they do spend time on preparation which the irs realizes is a reality something to keep in mind now this might be a good time to discuss substantiation what is substantiation it's basically your ability to show to prove to the irs that what you are claiming the time you are claiming is accurate so this is the way the flow usually goes if the irs is auditing somebody first the taxpayer is going to claim real estate professional status secondly the irs disputes it at this point the burden of proof lies with the taxpayer they have to show they have to substantiate their claim and they can do such with receipts with logs calendars emails many different ways of doing it but usually something that has to paint a complete picture that tells us consistent story the irs can call character witnesses and what they are trying to determine is and they can use their own discretion is if the taxpayer is credible so if somebody is trying to game this system it's going to be very difficult and they're setting setting themselves up for for difficulty later but it's an amazing opportunity for somebody who's actually trying to become a real estate professional so now back to the substantiation by the taxpayer providing the irs with proof with substantiation the burden of proof falls back on the irs to dispute that and that's basically the position that you me as a taxpayer want to be in one we want to have all of our support that paints a consistent picture available to give to the irs if necessary now also in order to substantiate for the second point of becoming a real estate professional in order to substantiate that the time spent as a real estate professional or on real property trade or business is more than half of the time the taxpayer spends on personal service activities they must also keep a log of their non-real property trade or business hours does that make sense for example if you're saying hey i spent 21 hours on real property trade or business the irs is going to say well hey how do i know you did not spend 30 hours on a different in a different field a different personal service activity so you have to have a log a credible log showing the hours spent on your non-real property trade or business business activity calendar invites emails anything like that is going to be fair game is going to be very helpful uh phone logs if if those are available through your provider is going to be very helpful so that is concludes our step number two now for the third and final step which is shorter than the first two because we've already gone over the definitions is that the taxpayer has to materially participate in each of the real estate rental activities so recall that a spouse can be used to pull in the rental real estate activity of a activity that the real estate professional did not materially participate in now there's one exception to the rule that each rental real estate activity has to have material participation and it is a real estate professional can elect permanently elect to combine all of their rental real estate activities and have them be considered as one activity there are some tax implications permanent tax implications so before do making such an election please delve into that topic a lot more uh carefully and that is basically the three steps now there's a few caveats that i'd like to mention one is that recall that material participation had seven tests one of them was that a person a taxpayer had to spend 500 hours on the activity but the real estate professional requirement requires 750 hours so don't get confused with the material participation test and the real estate professional status qualification if a person meets that uses that first material participation test and they have 500 hours in the real in real estate activities they still have to have material participation of an additional 250 hours in a different different real property trade or business in order to qualify for a real estate professional got it okay moving on a limited partner if somebody is a limited partner they can only establish material participation in that activity by meeting there's number one five or number six we're not going to talk about it again you can look back you can look it up either material participation tests one five or six in order to deduct those losses if you are a limited partner now this last point is that even if a taxpayer materially participates in the real the rental real estate it's still going to be considered passive if they're not a real estate professional right we know that and conversely if a real estate professional if somebody qualifies as a real estate professional but they do not materially participate in the rental activity in a rental activity then they will not be able to to deduct those losses from the non-passive income just two sides of the same coin now we're going to get into the real estate passive activity tax hack are you ready are you ready let's do it now for the moment we've all been waiting for there is an activity there is something that would allow you to take rental real estate losses and deduct them from your non-passive activity and you do not have to be a real estate professional professional are you ready and it is called a short term rental anticlimactic possibly but listen up not just any short-term rental there are three amazing outcomes of being very particular with your short-term rental and knowing what the rules say so when treasury regulation section 1.469-1 e32 a blah said it said that a rental activity if a rental activity is less than seven days on average it's not considered a rental activity if if you are renting a home or a property for less than seven days on average then it is not it is not considered considered a rental activity now what does that mean exactly there are three potential implications one is do the hours on it count towards the real estate professional status two where does it go does it go on schedule e or schedule c and three does it what do the passive activity loss rules how do those rules affect this activity three so the first answer is does it qualify as realistic professional status you want the short answer it's yes you want the long answer you want the explanation the reason why which is super fascinating because the courts didn't think it did initially is in 2001 bailly versus the commissioner the court determined that it could not why they said because because of the fact that it's not a rental real estate activity then the taxpayer could not combine could not aggregate the hours could not aggregate that rental real estate activity for the short-term rental with their other rental real estate activity and thus that was proof to the courts that it would not it should not qualify the time spent on that should not qualify for the rent for the real estate professional status however in 2002 not sure exactly when this was but the lucero versus v the commissioner they determined right that the real property trade or business has its own qualifications which is material participation in a real property trade or business right so in order for the real estate professional status you had to materially participate in a real property trade or business of which short-term rentals is one so therefore overturn the previous court and it does qualify for real estate professional status second item which schedule should it go under if you're familiar with schedule c and schedule e scheduled c is for a business actually significant participation there goes that word again that term again significant participation so if you are providing significant services if you're providing significant services to your renter such as maid services then it would go under the schedule c if not it should go under the schedule e the difference as far as taxes goes is the schedule c is going to have about over 15 percent in self-employment taxes schedule e will not so if you wanted to go into the schedule e do not provide significant services if you want it to count towards your 750 hours real estate professional status make sure you're are you are materially participating in those and you have to understand the is how you materially participate for example taking up the trash is not a significant service that is specifically called out in the schedule e instructions but that would qualify as time spent in for material participation so you want to make sure that you are materially participating but you're not providing significant services if you wanted to go under the schedule e but you also wanted to qualify for the 750 hours rep status lastly what do the passive activity loss rules have to do how do those rules affect the short-term rental that's not considered a rental according to the treasury because it's less than seven days well here is very interesting so because it's not considered a rental then you would be able to you would be able to deduct those phantom losses those losses against your non-passive income it's not a rental it's not a rental so it doesn't even fall under the passive activity loss rules when that rule was created the passive activity loss ruled that that was a seven day or less average seven day rental was explicitly excluded from those so it falls back to way in the beginning when i mentioned the history when all losses could be deducted from your any income it's completely excluded from it so that activity inc losses from that activity can be deducted from your non-passive activity and in closing thank you very much for staying with me to the end and if you enjoyed this if you learned something from it please let me know in the comments please hit the like button share it if you know anybody that might benefit from it in your network and if you want to get a hold of me you can reach me at michael.wander wandercpa.com i'm on facebook i'm on linkedin uh active on tick talk and uh instagram as well and i look forward to uh hearing hearing from you and uh keep your eye out for additional movies coming out have a great rest of your day

Channel: Wander CPA

Views: 2,677

Keywords: real estate professional time log, real estate professional status tax benefits, is a landlord a real estate professional, real estate investing, make money real estate, real estate investing for beginners, material participation rules, material participation, Short term rentals, tax benefits of rental property, tax benefits of real estate, tax code, 469, irs, irs tax code 469

Id: nBGth608HIc

Length: 26min 30sec (1590 seconds)

Published: Tue Apr 06 2021