Many real estate investors who maintain a job, a business, a profession, outside of their real estate investing business, have no idea that their real estate investing deductions and offsets may run afoul of the current IRS rules that may come into play with their rental properties to their great detriment and expense. To be careless with this may cost you dearly and the IRS is awfully unforgiving even if you have records and professional backup that say otherwise.
If you deem yourself to be a real estate professional, make certain that you are sitting within soundly established IRS guidelines because there exists a limitation to the passive loss limitation rules when you generate net rental income and attempt to deduct real estate rental activity losses. Accordingly, a real estate professional is not what you may think it is. The applicable law institutes a specific time based test whereby a real estate professional is someone who spends a minimum of 750 hours annually and more than 50% of their time working as a real estate professional. It is all about how you may classify your real estate rental activity. It goes without saying, you ought to be consulting with competent counsel or appropriate tax professional to ensure you stand in conformance with tax law if rentals make up a portion of your business model and income stream.
First of all, you must materially participate in a real estate business. The business of renting and leasing real estate qualifies. Next, you must establish that more than 50% of your personal services that you perform in the real estate businesses you materially participate in. Third, material participation in the business or businesses must amount to more than 750 hours annually. You cannot count any work that you do and perform in your capacity as a real estate investor.
Moreover, each of your real estate interests are deemed a separate activity unless you make an election to treat all your businesses as a single activity. If you do not, you may create for yourself an Everest climbing standard to satisfy those guidelines.Those tests are applied annually and what may work for you one year, may not the following year.
Qualifying as a real estate professional can be very tax friendly to the taxpayer investor in a business of real estate rentals indeed. However, that taxpayer investor must be vigilant with his or her record keeping, document everything,and be aware of the required guidelines if the IRS comes “door knocking”. If the IRS deems that you have run afoul of the law, any money you thought you may have saved, may be completely negated by additional legal and accounting fees incurred, penalties and interest assessed, and how do you put a price on the stress of having the IRS on your back? To be sure, this is a very heavily litigated area of the tax code and you do not want to be in the IRS cross hairs. Even if you win in the end you may lose and it may cost you significantly in time and money.
It is noteworthy that whenever the IRS is regularly involved, there are always exceptions to guidelines and multiple correct interpretations to consider.
Ask yourself, and have the documents and records to prove it, have you materially participated in a business you own providing personal services to same in excess of 50% of your time and spent more than 750 hours of your time annually performing those services. If you did not, you are not a real estate professional. If you did you must take the additional step of taking the grouping election so that all the activity is declared non passive and will qualify. That grouping election is an irrevocable written instruction attached to your tax return expressly advising the IRS of your election.
In conclusion, if your real estate practice encompasses rental activities and you intend to take applicable deductions and offsets as a real estate professional, please consult with your tax advisor to be counseled on your unique circumstances to determine the correct tax treatment you may follow. It is always good practice to well document everything you do but when it comes to tax provisions often disputed and litigated, do it to ensure the IRS does not take a contrary posture.
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