Real Estate Professional Status
Owning rental property can be a great way to shelter income.
Elizabeth Carlassare
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Real Estate Professional Status
Today’s topic is a tax shelter for real estate professionals.
Owning rental property can be a great way to shelter income from Uncle Sam. Two episodes ago, I talked about how it’s possible to shelter a portion of your income from taxes with rental real estate losses, including paper losses from depreciation. In this episode, I want to explain how you can shelter even more of your income from taxes with real estate.
Are You Eligible?
To recap, as long as your modified adjusted gross income is $100,000 or less, you can deduct rental real estate losses of up to $25,000 from your earned income, whether you’re single or married and file jointly. To take the deduction, you must own at least 10% of the rental property and be responsible for significant decisions affecting it. If your income is higher, the deduction phases out: it’s reduced 50 cents for each dollar your modified adjusted gross income exceeds $100,000. For incomes above $150,000, the deduction is no longer available.
If you’re not eligible for the deduction, you don’t lose it. You can carry forward real estate investment losses indefinitely to future years. And, you can use them when your income falls to a level that makes you eligible or to offset your capital gain when you sell a rental property.
Is There an Exception?
But is there a way to deduct more than $25,000 in rental real estate losses from your other income? And, if you are not eligible to deduct rental real estate losses because your income is too high, is there an exception? The answer to both these questions is yes!
If you qualify as a “real estate professional” for the tax year, you are no longer limited to a maximum deduction of $25,000 in passive losses against your other income on your tax return. Instead, the deduction is unlimited. Let me repeat that: As a real estate professional, there is no limit to the amount of real estate losses you can deduct from your earned income.
Who Qualifies As a Real Estate Professional?
Ok, so what qualifies a person as a “real estate professional”? As defined by the IRS , to qualify as a real estate professional, you must meet both of the following two criteria:
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First, more than half of the personal services you provide (that is, at least half of your work hours) for the tax year must be in a real property trade or business (including rental real estate activities). If you are an employee in a real estate-related business, your activities count only if you own more than 5% of the business.
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Secondly, you must work more than 750 hours during the tax year in a real property trade or business.
And what counts as a “real property trade or business”? The IRS’s definition is very broad: A real property trade or business is any business that develops or redevelops, constructs or reconstructs, acquires, converts, rents or leases, manages, or brokers real estate. Your activities overseeing your own rental real estate count toward the real estate professional status.
If you do qualify as a real estate professional, you’ll want to keep a log of the time you’re spending on your real estate-related activities.
If you’re married and file jointly and you or your spouse qualifies as a real estate professional, you can apply the deduction to both your incomes. Let’s take an example. Let’s say Jenny and Bill are married and Jenny is an executive at a pharmaceutical company and her salary is more than $150,000. Bill retired early and spends more than 750 hours a year managing the couple’s rental properties. Because Bill qualifies as a real estate professional, the couple can deduct all of their rental losses from Jenny’s earned income. [[AdMiddle]
The real estate professional status can be an excellent tax shelter if you meet the criteria. Remember, as a real estate professional, the rental real estate losses (including losses from depreciation) you can deduct are unlimited.
As always, everyone’s situation is different, so be sure to consult a tax or financial advisor before making important financial decisions. This podcast is not a substitute for professional advice.
Administrative
Today, I’m giving away two copies of Real Estate Advantages by Sharon Lechter and Garrett Sutton. This book explains real estate professional status and other tax and legal strategies used by successful real estate investors. It’s included on the list of summer reading posted on the Money Girl website at quickanddirtytips.com. This week’s winners are Samantha in San Francisco and Iann C. Congratulations! Be sure to check your email for instructions and enjoy the book!
Cha-ching! That’s all for now, courtesy of Money Girl, your guide to a richer life.
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Related links:
o IRS Publication 527, “opens PDF file Residential Rental Propertyopens PDF file ”opens PDF file
o Real Estate Professional Criteria
o IRS Publication 925, “Passive Activity and At-Risk Rulesopens PDF file ”opens PDF file
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