For high-income investors, obtaining real estate professional status, or REPS is an effective tax strategy. Your tax exposure will become very little, and you can save more dollars when you claim REPS. By deducting considerable passive losses, such as depreciation from real estate operations, you might be able to lower your taxable income. That is the case when you are fulfilling the criteria of being a real estate professional.
What is Real Estate Professional Status or REPS?
Anyone who meets the requirements can claim to spend most of their time working on real estate and associated tasks by using the designation “real estate professional status” or REPS. That is one of the unique advantages provide by the legislation to promote certain activities. If real estate is your major line of work, you can file for REPS.
What You Can Get Through REPS?
Real estate professional status allows you to transform passive losses into deductible ordinary losses. REPS might drastically reduce your tax obligation if you invest in rental real estate. You can reduce your tax bill from 35% to 15% or even less.
Requirements To Claim REPS – Necessary Elements to Know Before REPS Qualification
To be eligible for REPS, you must pass all three tests—the over 50% of the time test, the 750-hour test, and the material participation exam. You can attempt these tests only once a year. You can meet the requirements to be a real estate professional in some years but not others. Because of this, the same real estate activity may result in passive losses in some years and non-passive losses in others. Let’s examine these circumstances in detail.
The following are the conditions (tests) you need to fulfill if you are pursuing REPS:
More than 50%
Your real estate business accounted for more than half of the personal services you provided throughout the tax year.
750+ Hours
During the tax year, you put in more time than the require 750 hours in real estate trades or companies.
Material Participation
All hours recorded must be considered as being material participation as defined by activities in IRS Code Section 469(c)(7).
You spend more than 50% of your time working on real estate than any other business/job (Test no.1)
Are you spending more than half of your time working at another employment? It will be challenging to obtain real estate professional certification. Additionally, you must put in a minimum of 750 hours in the real estate industry. A large portion of this must be spent on ongoing property management tasks.
What Steps you Should have to Take for Time Test (Test no.2)?
real estate professionals must meet specific criteria to qualify as such under the IRS rules, which include spending more than half of their working hours and over 750 hours annually in real property businesses in which they materially participate. This designation is crucial for the purpose of bypassing the passive activity loss rules, allowing them to deduct losses from real estate activities against other forms of income.
What is Material Participation (Test no.3)?
For professional real estate investors, the criteria to establish material participation in real estate activities are tailored to reflect the specific nature of their business. While the general seven tests for material participation apply, the IRS provides certain exceptions and special rules that can affect how real estate professionals meet these criteria, particularly in relation to the 500-Hour Test and the Facts and Circumstances Test. Here’s a modified overview of the seven tests for material participation with a focus on real estate professionals:
500-Hour Test: The real estate professional has actively participated in a real estate activity for more than 500 hours during the tax year. For real estate professionals, this can include a wide range of activities related to property development, acquisition, rental, or management.
Substantial Participation Test: The investor’s involvement constitutes almost all of the operational activities for the real estate project within the tax year. This underscores the investor’s hands-on role in the day-to-day management or development of the property.
100-Hour Plus Test: The real estate professional has been involved in the activity for over 100 hours during the tax year, and their involvement is at least as much as any other individual participating in the project. This test emphasizes the comparative aspect of participation among all involved parties.
Significant Participation Activities Test: The activity qualifies as a significant participation activity, where the real estate professional has participated for more than 100 hours. For professionals with multiple real estate activities, their combined participation across all significant participation activities exceeds 500 hours during the tax year. This test is particularly relevant for investors managing multiple properties.
Five of Ten Years Test: The real estate professional has materially participated in the real estate activity for any five of the previous ten tax years. This long-term involvement criterion recognizes the cyclical nature of real estate investments and management.
Personal Service Activities Test: This test is less relevant for real estate professionals as their activities typically involve significant capital investment and are not considered personal service activities by the IRS.
Facts and Circumstances Test: Based on all facts and circumstances, the real estate professional participated in the activity for more than 100 hours during the tax year, and their participation was regular, continuous, and substantial. This test allows for flexibility, considering the varied nature of real estate activities.
What Activities Will Make You Eligible for Material Participation
Simple active involvement in managing real estate assets is known as “material participation.” If you purchase and lease commercial buildings or apartments while managing these assets on a daily basis, you could be eligible.
The definitions in the Internal Revenue Code are comprehensive. Any of the following activities spent in a real property trade or business would qualify in accordance with IRS Code Section 469(c)(7):
1. Real Property Development
2. Redevelopment
3. Construction
4. Reconstruction
5. Property Acquisition
6. Conversion
7. Rental
8. Operation
9. Management
10. Leasing
11. Brokerage trade or business