IRS said Real Estate Agents are not Real Property Professionals
Does a real estate agent qualify as a real estate professional for the purposes of deducting rental expenses from regular income?
Tax Consequences of Passive versus Active Income
Generally speaking taxpayers cannot offset their earned income with deductions or losses derived from “passive” activities. A passive activity is any activity that involves the conduct of any trade or business,and in which the taxpayer does not materially participate.
As a result, many arguments arise from whether losses incurred by a taxpayer were “active” (and can be deducted) or “passive” (and either cannot be deducted or are limited in their deductibility).
Exception for Real Estate Professionals
With certain exceptions rental activities are automatically treated as passive activities. An exception relevant here is available for “qualifying taxpayers” who satisfy the real estate business participation requirements to be classified as “real estate professionals.” Contrary to the general rule, a rental real estate activity of a real estate professional is a non-passive activity for the tax year if the taxpayer materially participates in the activity.
To qualify as a real estate professional a taxpayer must perform (i) more than one-half of her personal services performed during the tax year in the real property trades or businesses in which the taxpayer materially participates and (ii) more than 750 hours of services during the tax year in real property trades or businesses in which the taxpayer materially participates. A taxpayer who owns at least one interest in rental real estate and who meets the above requirements is a qualifying taxpayer (commonly referred to as a “real estate professional”). A taxpayer may elect, at the time of the filing of their tax return, to have all of their rental properties grouped together to count as one single activity in order to more easily reach the 750 hour minimum by submitting a statement as such to the IRS.
This is where we believe the examining agent made a mistake of law. The real property trades or businesses in which a taxpayer must materially participate in order to qualify as a real estate professional do not necessarily have to involve the rental of real estate. In addition to the renting and leasing of realty, real property trades or businesses include: buying, operating, and managing realty, as well as the realty brokerage business. Thus, for example, a real estate broker who materially participates in the brokerage, and who, with respect to that business, satisfies the more-than-50%-of-personal services requirement and the more-than-750 hours requirements discussed above, qualifies as a real estate professional, whose rental real estate activities are not automatically treated as passive.
A taxpayer claiming to be a real estate professional must establish the number of hours of services performed in real property trades or businesses by any reasonable means, including through use of appointment books, calendars or narrative summaries.
Material Participation
Material participation is the involvement in an activity’s operations on a regular, continuous and substantial basis. Under Reg §1.469-5T(a), material participation will be found when ether:
(i) the individual participates in the activity for more than 500 hours during such year, or
(ii) the individual’s participation in the activity for the taxable year constitutes substantially all of the participation in such activity of all individuals (including individuals who are not owners of interests in the activity) for such year, or
(iii) the individual participates in the activity for more than 100 hours during the taxable year, and such individual’s participation in the activity for the taxable year is not less than the participation in the activity of any other individual (including individuals who are not owners of interests in the activity) for such year, or
(iv) the activity is a significant participation activity for the taxable year, and the individual’s aggregate participation in all significant participation activities during such year exceeds 500 hours, or
(v) the individual materially participated in the activity for any five (5) taxable years (whether or not consecutive) during the ten (10) taxable years that immediately precede the taxable year, or
(vi) based on all of the facts and circumstances, the individual participates in the activity on a regular, continuous, and substantial basis during such year.
Under Reg §1.469-5T(b), the facts and circumstance to be considered are whether any person (other than such individual) performing services in connection with the management of the activity receives compensation described in section 911(d)(2)(A) in consideration for such services; and whether any individual performs services in connection with the management of the activity that exceed (by hours) the amount of such services performed by such individual.
Under Reg §1.469-5T(c), an individual is treated as significantly participating in an activity for a taxable year if the individual participates in the activity for more than 100 hours during such year.
Concerning spouses filing a joint return, for a taxpayer to qualify as a real estate professional, she must separately satisfies the above tests, without regard to the other spouse’s services.
[The information provided above is for informational purposes only and is not to be considered legal advice in any way. For a free consultation, call us today at 952-886-7141]
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