- The video introduces TaxSmart Daily, a series for real estate investors to explore tax topics and save money
- Brandon Hall, managing partner at the real estate CPA, is starting the series to address common tax and accounting questions
- Viewers are encouraged to subscribe to the YouTube channel for notifications on new videos and to join the Tax Smart Real Estate Investors Facebook group and newsletter
- The topic of the video is real estate professional status, which can save investors money by allowing them to use rental losses against regular income
- Passive activity loss rules state that passive losses can only offset passive income, not non-passive income
- Real estate professional status can change the classification of rental activities from passive to non-passive, allowing for greater tax flexibility
- To qualify as a real estate professional, one must spend 750 hours a year in real property trades or businesses and more time in real estate than any other material participation activity
- There are 7 tests for material participation, with the most common being spending 500 hours or spending 100 hours and more than anyone else in rental activities
- If one qualifies as a real estate professional and materially participates in rental activities, rental losses can be used to offset non-passive income
- Material participation is assessed on a property-by-property basis, but a grouping election can be made to treat all rental activities as one for material participation purposes.

- The speaker discusses the concept of material participation in rental activities and how it affects passive losses.
- Real estate professional status is important for reclassifying passive losses and offsetting other income.
- Mistakes to avoid include not materially participating in rental activities, counting hours that don't count, and not making the grouping election for rentals.
- Education, research, and investor level hours do not count towards material participation or real estate professional status.
- Travel time may or may not count depending on the circumstances.
- Advisors who suggest 500 material participation hours plus 250 hours of anything else may be incorrect.
- Making the grouping election is crucial for treating all rentals as non-passive.

The very FIRST episode of our new series: Tax Smart Daily. This is a daily (weekdays) video series covering tax topics and answering questions real estate investors are asking across our social platforms. 

Today's topic is Real Estate Professional Status... enjoy!
—

Here are 3 ways to get involved:

1: JOIN OUR FACEBOOK GROUP

https://www.facebook.com/groups/taxsmartinvestors

If you haven't joined the Tax Smart Real Estate Investors Facebook community, you need to jump on it ASAP! You'll get details on exclusive Live Q&As that I'm doing, updates on everything tax and accounting, and early access to events and content. 

2: FREE TRIAL OF OUR NEWSLETTER

https://hubs.ly/H0-r1Tf0 

Interested in getting our premium Tax Strategy Newsletter every Tuesday? It breaks down the nuances of real estate investor taxation in an easy-to-read manner and contains investor tools and presentations.

3: WORK WITH US

https://hubs.ly/H0-r1Tf0 

Interested in working with our accounting firm at The Real Estate CPA? We are a boutique CPA firm providing advisory, tax, and accounting services to real estate investors and business owners across the U.S.

Let's connect:

Facebook: https://www.facebook.com/realestatecpa
LinkedIn: https://www.linkedin.com/in/brandonha...
Twitter: https://twitter.com/therecpa
Podcast: https://www.therealestatecpa.com/podc...
Website: https://www.therealestatecpa.com/

Subscribe to our Tax Smart Investors Newsletter for exclusive content and tax updates: https://share.hsforms.com/15hwWMEKzTBeES_Dk2kDFLg311bf

Hey there, welcome to the first iteration of TaxSmart Daily, a daily video series for real estate investors exploring tax topics that will help you save money and hopefully stay out of trouble with the IRS or state governments.

I'm Brandon Hall, I'm managing partner at the real estate CPA, a CPA firm working exclusively with real estate investors on tax and accounting issues.

I'm starting this series because we get tons of tax and accounting questions on a daily basis.

So I figured why not document some of this for everybody else out there that probably has the same questions.

Before we get started, I invite you to subscribe to our YouTube channel so that you'll get notifications when we drop new videos, whether it be the TaxSmart Daily, the Real Estate CPA Podcast, live Q&As, webinars, anything like that.

We upload them to YouTube and I don't want you to miss out.

Also check out the tax smart real estate investors, Facebook group and the tax smart newsletter.

The links to the, to join both of those are in the description of this video.

Lastly, if you have any questions or if anything that I say resonates with you, please, please, please leave a comment on this video with a timestamp referencing what you're talking about.

Your comments and feedback are my oxygen.

Today's topic is real estate professional status.

It's always a big topic with real estate investors because real estate professional status, the qualifying as a real estate professional is the difference between saving tens of thousands of dollars in tax, thanks to the ability to use your rental losses against your regular income.

So if you can qualify as a real estate professional, you have a lot of tax flexibility.

If you can't qualify as a real estate professional, your rental losses get suspended.

So let's talk a little bit about what this actually means.

Now, when I say real estate professional status, I'm talking about the tax status.

So I'm not talking about getting my real estate license and then being a real estate professional for LinkedIn purposes, right?

I'm talking about the actual tax status, real estate professional status.

So we're gonna be looking at IRC section 469.

That's where all of this is is documented and that's what we're talking about on today's video.

Well the passive activity loss rules, we have to start there with the passive activity loss rules.

The passive activity loss rules say that passive losses can only offset passive income.

Non-passive income is my W-2 income, my business income, my gain on Apple stock sale income, my dividends, my interest, that's all considered non-passive income.

My passive losses from my rental real estate cannot offset non-passive income.

My passive losses from rental real estate can only offset passive income.

1, all rental real estate, unless you qualify as a real estate professional to any trade or business in which you do not materially participate.

If a passive activity generates passive income, then a passive activity that generates a passive loss can offset that passive income.

So I can have rental A that generates passive income of $10,000.

And then I can have rental B that generates a passive loss of $10,000 and they can offset each other for a net 0.

I can also have a business that is my, that generates passive income.

Maybe I don't materially participate in it.

However, I've set that up generates passive income.

My rental loss, that's a passive loss can offset the business passive income.

So passive income from 1 source can be offset by passive loss from another source.

The problem though, for real estate investors is that my passive losses cannot offset my non passive income.

So my, if I, if all I have is a rental A or B or C, or maybe I have a hundred rentals, they all generate passive losses.

I cannot use those passive losses to offset my W-2 income, my business income that is non-passive, that I do materially participate in, my capital gain income, my interest, my dividends, I can't use my passive losses from my rental real estate activities to offset those income sources.

So what happens is I accrue these large passive losses.

They become suspended on my tax returns and they carry forward year to year until I generate enough passive income or until I sell a passive activity at a gain to then offset those, those passive losses with.

So really critical to understand that rentals generate passive losses.

Now we said that there were 2 types of, of passive activities.

1, all rental activities, unless you qualify as a real estate professional to any trade or business in which you do not materially participate.

So all rental activities are passive by default unless I qualify as a real estate professional.

That's why real estate professional status is so important.

It allows me to overcome the presumption that all of my rentals are automatically passive activities, and it allows me to potentially qualify it as a non-passive activity.

So to qualify as a real estate professional, I have to spend 750 hours a year in real property trades or businesses.

I also have to spend more time in real property trades or businesses than I do in any other material participation activity.

More time in real estate than anywhere else.

If I have a full-time job, a full-time W-2 job, or if I'm running a CPA firm full-time like myself, I can't qualify as a real estate professional because I spent 2080 hours a year.

It's presumed that I spent 200, 2080 hours a year at my full-time job or running my business.

So to argue that I spent an additional 2081 hours in real estate would be a really tough argument to substantiate if you were ever audited because what you would be then telling the IRS is I spent more time in real estate than I spent at my full-time job but combined that means that I spent like 4,100 hours in both of these activities.

And that's going to be really difficult to do unless you have a massive portfolio and you're self managing that massive portfolio, which most people are not actually doing.

So if you have a full-time job, you're probably out from qualifying as real estate professional.

If you're married, though, your spouse can qualify as a real estate professional.

So maybe you have a homemaker spouse, they they spend 750 hours in real property trades or businesses.

So they qualify as a real estate professional on a married filing joint return, you get the benefit as a result, even though you have a full time w 2 job, your spouse qualifies as a real estate professional, your rental properties may be non passive.

Because even though you qualify as a real estate professional, you spend 750 hours a year in real property trades or businesses, you spend more than half your time in real property trades or businesses, you qualify as a real estate professional, it doesn't mean that your rentals are non passive, it just means that you overcome the default classification that your rentals are passive, but you still have to materially participate in your rental activities.

There are 7 tests for material participation.

The 3 that we see most often are spending 500 hours in the rental activities, spending 100 hours and more than anyone else in the rental activities, or your your participation is substantially all of the participation in the rental activities.

Now those last 2, 100 hours and more than anyone else.

If I have a property manager That's spending 200 hours a year managing my rental activities.

I have to spend 201 hours To hit 100 hours and more than the property manager more than anyone else So I've spent 201 hours managing the property if I spend 199 hours I've spent 100 hours, but I haven't spent more than the property manager.

I might have to look at that 500 hour test as a result.

The, the last test that I mentioned, the substantially all.

So my participation is substantially all the participation.

If I have really anybody else working on the rental activities, then my participation is probably not going to be substantially all the participation.

But if I'm self-managing my rental activities, I'm doing the repairs myself, I'm doing the maintenance myself, I'm coordinating with tenants myself, I'm doing everything myself, then I don't have to hit 500 hours.

I don't have to hit 100 hours more than anyone else.

I could probably get away with 60, 70, 80 hours a year if nobody else is doing anything related to those rentals because my participation, even at 60 hours, is substantially all the participation in the rental activities during the year.

So you have to qualify as a real estate professional.

You have to spend 750 hours in a real property trade or business, and you have to spend more time in real property trades or businesses than anywhere else.

You also have to materially participate in your rental activities and there are 7 tests for material participation but like I said the 3 that we see most often are spending 500 hours, spending 100 hours and more than anyone else or your participation is substantially all the participation.

Assuming that you meet the 2 tests to qualify as a real estate professional, again, 750 hours, more time in real estate than anywhere else, and that you materially participate in your rental activities, your rental activities will be considered non-passive.

Any loss generated from the rental activities will also be considered non-passive and you'll be able to offset your W-2 income, your business income, any other type of income.

Typically without limits, except this year we've got the excess business loss limitations and going forward we have the excess business loss limitations which we're not going to get into right now.

Just know that there are potentially limitations depending on how large your loss is.

So if I qualify as a real estate professional and if I materially participate in my rental activities, my rental activities are non-passive.

Now material participation is looked at on a property by property basis.

So if I have 10 properties and I materially participate in 1, but not the other 9, then the other 9 are still passive.

I can make a grouping election to aggregate all rental activities into 1 and treat them as 1 for material participation purposes.

So in that case, I'm material to participate in 1 rental.

I make the, not the, the aggregation election to group all rentals together as 1.

Now all 10 rentals are non-passive for me.

So now all 10 rentals, I can use the losses for all 10 rentals against my W-2 income.

Now, we kind of talked about why real estate professional status is important, but let's talk about passive losses real quick, or just losses in general from our rental activities real quick.

So rental activities will typically generate a paper loss even if there's net operating income and we generate that paper loss because of depreciation and we can do different we can do things to accelerate depreciation like a cost segregation study and bonus depreciation.

So it's really critical that you plan your real estate professional status and your material participation around years that you're going to be able to juice your losses from your rental real estate, accelerate those losses from the rental real estate.

Maybe I'm doing a cost segregation study.

And in those years, my rental real estate, instead of generating a $2,000 tax loss, now it's going to generate a $15,000 tax loss.

Well, I probably want to figure out how I can utilize that tax loss to the fullest to get an immediate tax refund or an immediate tax benefit.

As a result of reclassifying that, making it a non passive loss for tax purposes.

So we've talked about passive loss rules.

Passive losses can only offset passive income.

We've talked about why real estate professional status is important, because it allows you to recharacterize or to move those passive losses out of that passive loss bucket and into the non-passive loss bucket, and then offset your other income, your W-2 income, your regular income.

So really powerful if you can qualify as a real estate professional.

Now let's talk about some of the mistakes that we see people make, people and their advisors make.

The first mistake is forgetting that you also have to materially participate in the rental activities.

So again, you have to spend 750 hours and more time in real estate to qualify as a real estate professional.

But all that does is it allows you to overcome the presumption that your rentals are passive.

They're still passive unless you also materially participate in the rental activities.

Everybody always says, Oh, go get your real estate license.

Not true because for real estate professional status purposes for the internal revenue code, it's all about the hours that you spend in real property trades or businesses.

I put together buyers and sellers of real property all day long, that's all I do.

I hit 2,000 hours a year being a real estate agent.

So I've exceeded my 750 hours in a real property trade or business brokerage is 1 of those real property trades or businesses and agents count as brokers for the purposes of that code section.

So I spend 2000 hours a year in a real property trade or business being a real estate agent.

Since I spend 2000 hours a year and it's all I do.

It's also more time in real estate than any other activity that I participate in.

I hit more time in real estate than anywhere else.

I'm a real estate professional, but let's say that I didn't participate in my rentals.

Let's say I have 3 rentals and they have property managers on them and I don't want anything to do with them.

Even though I'm a real estate professional for tax purposes, my rentals are still passive because I did not take the extra step of ensuring that I materially participated in my rental activities.

You know, we run into issues with real estate agents and brokers, property managers, flippers, developers, and builders.

People that are are doing real estate full-time legitimately, but they forget to materially participate in their rental activities.

So always make sure that you come back to the rental activities and ask, how can I materially participate in these rental activities?

The other big mistake that we see, or another 1 of the big mistakes that we see is counting hours that don't count.

Research and education hours will not count.

Investor level hours like reviewing financial statements, managing the property manager, doing bookkeeping, bill pay, filing tax returns.

None of that time is going to count towards material participation or towards real estate professional status unless you're involved in the day-to-day activities.

So if you're involved in the day-to-day management of the rental activities, then all of those hours will actually count.

But if you're not involved in the day-to-day management, meaning that you have a property manager, you're managing the property manager, all that is is investor level hours.

Investor level hours are not material participation hours and they're not real estate professional status hours.

You cannot count them towards any of the tests.

So be really careful with people that tell you that it's easy to qualify as a real estate professional.

It's not easy to qualify as a real estate professional because those hours don't count.

You have to actually be going to the property, swinging the hammer, structuring the leases, evicting the tenants, managing the tenants, managing the contractors, buying the supplies, shuttling them over to your house.

Make sure that you're counting hours that actually count.

Education and research time do not count.

And this is all substantiated by case law.

We have a 12,000 word guide on real estate professional status on our website, www.therealestatecpa.com.

Click education, click real estate professional guide.

It's got all the citations for you, but case law says investor level hours do not count education.

The last bucket of time that does not count typically is travel time.

Now, if you, if you are doing local travel because you're self managing your local real estate portfolio, then travel time has, historically counted.

But if you are traveling an hour away or you're doing it infrequently, the travel time is not going to count.

On the topic of hours that count and don't count, another mistake that we see is we see advisors say you only need 500 material participation hours and then 250 hours of anything else, or 250 hours of investor hours.

Because remember, 750 hours, more than half your time to qualify as a real estate professional, but also the material participation tests say 500 hours in a real property trader business.

So people say, Hey, if you spend 500 hours, you're good.

So what these advisors do is they'll say spend 500 hours in your managing your rentals, and then you can spend 250 hours doing anything else or doing investor level activities or whatever.

But the problem is, is that it doesn't actually work that way.

They, they, they want you to spend 500 hours to hit the material participation test and then 250 hours of anything else to hit the real estate professional status test.

So they'll say anything, any other hours count investor level hours count.

Like, like I'd said, just 30 seconds ago, the time that doesn't count is investor level hours, unless you're involved in the day-to-day management, education and research hours does not count.

So don't get suckered into believing that that time counts towards the real estate professional status test.

And if you ever hear anybody say 500 hours plus 250 of anything else, red flags should go up.

Are you sure that that's the time that actually counts here.

And then the last the last big mistake that we see is not making the grouping election.

So if I fail to make the election to group all of my rentals into 1, then I have to materially participate in each rental separately.

So in my 10 property example, if I only materially participate in 1 rental, then only that 1 rental is non-passive.

So I have to make the grouping election to make all of them non-passive.

If I don't do that, if I don't make that grouping election, then the other 9 rentals are still passive.

They're still subject to the passive activity loss rules.

I can, there's actually a safe harbor where you can retroactively, fix that now, but, it is definitely an audit and audit issue that the IRS would attack if they, if they found out that you didn't actually make that grouping election.

So make sure that you make that grouping election.

Time stamp that comment with anything that resonated with you or any questions that you have.

Would love to interact with you and help you gain some clarity on, on, on whatever outstanding questions you have.

I'm going to be launching another 1 tomorrow and we'll, we'll get into the habit of doing it.

I'm not going to do weekends, but I will do weekdays every single day.

And I would love for you to participate in the ongoing learning that we're doing and help me drive new content as well.

So thanks a lot for listening to the first iteration of the TaxMart Daily.

See all Tax Smart Real Estate Investors transcripts on Youtube

How Qualifying as a Real Estate Professional Creates BIG Tax Savings [Tax Smart Daily 001]