The tax code can be a wonderful thing for real estate investors, especially for those who invest full-time. This is because there is a special rule that can save taxpayers, active in a real estate trade or business, thousands of dollars in taxes.
As you may already know, rental real estate often creates a loss for tax purposes due to depreciation. And while most investors are limited in the amount of passive losses they can deduct from their ordinary income, real estate professionals can deduct passive losses against their ordinary income without limits.
If you are not a real estate professional, you can deduct up to $25,000 of passive losses against your ordinary income if your AGI is $100,000 or less. This phases out $1 for every $2 of earnings until your AGI hits $150,000, then the deduction is completely eliminated.
If you made $95,000 in active income (i.e. your job) and had $50,000 in passive losses from real estate you could reduce your taxable income from $95,000 to $70,000, and assuming you’re in the 24% tax bracket, that’s $6,000 in tax savings.
The remaining $25,000 would be suspended until it can be used in future years, and if your income was $150,000+, you would receive no deduction.
However, if you are considered a real estate professional, you could deduct the entire $50,000, saving another $6,000 in taxes.
Being a real estate broker, agent, or simply working in a real estate trade or business does not make you a real estate professional for tax purposes.
A real estate professional, for tax purposes, is a person who works at least 750 hours, and more than half their annual working hours in that real estate trade or business. For this reason most individuals with full-time jobs do not qualify for this status.
However, employees who work in a real estate trade or business can use their working hours towards this requirement if they own at least 5% of the company.
For the losses from real estate activities to be deductible against ordinary income, the real estate professional must materially participate in each activity. Therefore limited partnership interests may be excluded.
Married couples can elect this status, if one spouse can meet these requirements. This typically works well when one spouse cannot elect this status being they work a full-time job, and the other doesn’t
You are a full-time real estate investor and spend 1,000 per year on your real estate business, and you are also a part-time blogger and spend 250 hours in your web business.
Because you spend over 750 hours, and more than half their annual working hours in that real estate trade or business you can elect to be taxed as real estate professional.
Qualifying as a real estate professional can save you thousands of dollars in taxes if you invest in rental real estate. However, due to the complexities in qualifying, you will want to consult a tax professional before planning to use, or electing this status.
Author: Thomas Castelli, CPA is a Tax Strategist and member of The Real Estate CPA, an accounting firm that helps real estate investors keep more of their hard earned dollars in their pockets, and out of the government's, by using creative tax strategies and planning.
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Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.
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