This episode of the real estate CPA podcast discusses the myths and strategies behind the real estate professional status. The hosts debunk several myths, including the idea that spending 500 hours in material participation and 250 hours in other activities qualifies as a real estate professional. They also clarify that material participation hours and real estate professional status hours are the same thing. Additionally, they explain that hitting 100 hours and more than anyone else does not automatically qualify someone as a real estate professional, as they still need to meet the minimum requirement of 750 hours. The hosts also dispel the myth that managing a property manager counts towards real estate professional status, unless it is a significant part of a larger operation. Lastly, they emphasize that education and research hours do not count towards real estate professional status, and caution listeners to ask for citations when receiving advice that contradicts this.

- CPAs interpret the tax code differently for real estate professional status because they are not fully aware of all the tax court cases
- Hitting real estate professional status is not easy and is heavily litigated
- Real estate professional status is not a loophole, it was implemented to stop a previous tax shelter loophole
- Reps hours do not carry over year to year, real estate professional status must be qualified for each year
- Qualifying as a real estate professional does not unlock previously suspended passive losses
- Strategy: Have one spouse qualify as a real estate professional to utilize the benefits for both spouses when filing jointly

- Strategy #2: Time your real estate professional status election to claim losses. Use retroactive cost segregation study to reclassify components of a building and take missed depreciation.
- Strategy #3: Run a separate real property trader business in addition to being a landlord to qualify as a real estate professional. Examples include flipping, developing, or being an agent or broker.
- Strategy #4: Buy local properties to qualify as a real estate professional and move passive losses from out-of-state investments into non-passive status.
- Strategy #5: Make a grouping election to group all rental activities together and meet material participation requirements for the entire portfolio.

- The speaker explains that being a real estate professional in one property does not automatically make a syndicate investment non-passive.
- The IRS looks for the 9 election to determine if the syndication investment is passive or not.
- Making the 9 election aggregates all rental real estate interests into one activity, allowing for material participation.
- Documentation is important for substantiating time spent in real estate activities and material participation.
- Spouses can combine their time for material participation purposes, even if one spouse is not a real estate professional.
- If unable to qualify as a real estate professional, there may be other strategies to take losses from rental properties against non-passive income.

- The short-term rental loophole allows rental property losses to be taken against non-passive income
- To qualify, the property must have an average stay of 7 days or less
- Material participation is required, which can be proven through spending 500 hours on the activity, doing substantially everything, or spending more than 100 hours with no one else spending more
- Spouse's time can count towards material participation
- The 7 day exception means that rental activities are not considered passive and do not require qualification as a real estate professional
- Words are important in the tax code, as section 469 states that all rental activities are passive by default unless qualifying as a real estate professional
- Don't get creative with the code and risk an audit, seek professional help if needed.

- The podcast episode discusses the myths and strategies surrounding real estate professional status.
- The hosts debunk myths about the qualifications for real estate professional status, such as the misconception that spending a certain number of hours automatically qualifies someone.
- They emphasize that education and research hours do not count towards real estate professional status.
- The hosts provide strategies for qualifying as a real estate professional, such as having one spouse qualify to maximize benefits when filing jointly.
- They also discuss strategies like timing the real estate professional status election to claim losses and utilizing the short-term rental loophole.
- Documentation is important for substantiating time spent in real estate activities and material participation.
- The hosts caution against getting creative with the tax code and recommend seeking professional help if needed.

Today we discuss 8 myths that surround qualifying as a real estate professional as well as several strategies that you can implement. There's a bonus at the end about short-term rentals too.
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Thank you for tuning into this episode of the real estate CPA podcast, your host, Brandon Hall and Thomas Costelli here.

And today this is episode number 3 of a 4 part series on the real estate professional status.

And what we're going to be discussing is the myths and strategies behind the real estate professional status.

Because if you've been tuning in to the last 2 episodes, you know that it is 1 of the most litigated parts of the task code.

And for good reason, people really, really, really wanna take their rental losses against their active or ordinary income or non-passive income, just to classify it there.

So we do want to set the record straight.

This is episode number 3 of 4, and we're going to be demystifying and providing some strategies on how you can actually qualify as a real estate professional.

And also, you know, if you've listened to the prior 2 episodes, if you haven't, you should, but if you've listened to the prior 2 episodes, if you haven't, you should, but if you've listened to the prior 2 episodes, you know that we're really big on telling people what they need to hear to win IRS audits, not what they want to hear to make their life easier.

Everybody wants to hear that education hours count that research hours count that investor time counts like going to conferences counts, none of that time counts.

So we're going to tell you what you need to hear not what you want to hear.

And that's also a part of the myths that we're going to go over are the myths are things that we've heard other practitioners telling their clients or education gurus telling their, their people.

And, and, and typically it's what you want to hear.

Because they're trying to sell you something, right?

So if you want to kick us off with myth number 1, I already harped on this for like, I had like a 5 minute soap off.

So for 1 of those prior episodes, I'll let you take the first 1.

So the first myth is that, is that you can spend 500 hours in material participation and then 250 hours of anything else in order to hit the real estate professional status.

And remember, to get the real estate professional status, you have to have at least 750 hours in a real property trader business.

And it must represent more than half of your total working time.

So what some people think is if they just do 500 hours of material participation, they could spend 250 hours doing whatever, listening to this podcast, other education seminars, conferences, doing research, you know, just browsing properties on Zillow or Trulio or LoopNet or just investor level activities, just reviewing financial statements and things of that nature.

500 hours of material, the material, let me back that up.

So you need to have 750 hours of material participation.

And again, I repeat, it is not 500 hours and then 250 hours of whatever you want, it has to be 750 hours of material participant material participation.

And that's exactly where, where, but it gets confused because they think that the, so the material participation test that we covered on last episode, it's 500 hours, substantially all of your participation or 100 hours and more than anyone else.

So what people do is they think that if I've hit the 500 hour material participation test, I am materially participating, it's then the 250 hours that I also need to hit a total of 750 for real estate professional status.

We've heard that they can be investor level hours.

We've heard that they can be investor level hours, we've heard that they can be education and research hours, like Thomas saying, listening to podcasts, going to conferences.

The problem with that is that to qualify as a real estate professional, you need to spend 750 personal service hours in a real property trade or business in which you materially participate.

You have to, every hour that you count towards the 750 hour test is a material participation hour.

So material participation hours, real estate professional status hours, they're the exact same.

People that tell you otherwise, ask for a citation.

Ask for a citation, because they don't exist.

They're not gonna be able to give you 1 because it doesn't exist.

Material participation hours and real estate professional status hours are different in characters.

So literally what we were just saying, a rep hour and a material participation hour, they're 1 and the same, they're synonymous.

This is because the 2 statutory tests for real estate professional status, very clearly call out the fact that you have to spend time in a real property trade or business in which you materially participate.

Number 3 is if I hit a hundred hours and more than anybody else that I am golden and you know, this might be true if you're just running, You know, real property trader business, excuse me.

If you're running a real property trader business, like maybe you're an agent or maybe you're a flipper outside of just being a landlord.

So just because you spent a hundred hours and you know, no 1 else spent more than you doesn't mean you automatically qualify.

You still have to hit that 750 hours to qualify as a real estate professional.

So just remember in order to qualify as a real estate professional, you're spending at least 750 hours and more than half your total working time as a real estate professional.

If you spend less than that, then you're not gonna qualify, period.

The fourth myth that we wanna cover is that you can invest out of state, manage your property manager, and still qualify as a real estate professional.

Basically that your management of your property manager hours count towards real estate professional status.

And that's a myth because typically, typically there's 1 caveat to this, but typically when you manage or supervise your property manager, It's not a material participation hour because what is a material participation hour?

It's an hour that's integral to the operations of the rental.

Meaning that you are participating on a day-to-day basis.

You would, or your rentals would not collect rents.

Your rentals would not be able to pay bills, they would fall apart.

If you weren't doing the hours supervising a property manager is not going to get you there.

It's not going to get you there, because the property manager is doing all that.

When I invest out of state, I've got 5 rentals and all 5 rentals have property managers on them.

I'm on the phone with them on an ongoing basis.

I'm making sure that the rentals are good to go, that we're collecting rents, any problems, that we're coordinating.

But managing the property manager is not gonna count.

They're doing all the material participation.

So that's why managing property managers is not going to work.

The caveat is if you have like 20, 30, 40 properties, And this is a either significant part of your day, not week, but day.

Like you have to daily manage this, or even better, if you've quit your job, retired or whatever, and you're doing this full time, and you're just coordinating between the 50 property managers you have, cool.

You're running a real property trader business.

That's an operation real property trader business at that point, right?

Real property operation, real property management.

Even though you're not the 1 that's going down there swinging the hammer, collecting the rents, you're still good.

But having my wife, you know, I run the CPA firm, having my wife, you know, call our out of state property manager for our 5 rentals once a week is not going to, it's not going to be significant.

It's not going to be material participation.

You have a sizable operation for that, for that to actually rise to that level of, of, of needing to happen.

And we harped on this on the last episode for everybody who tuned into that 1.

Again, if you didn't tune in, you should go listen to that 1 before you listen to this 1.

The education research hours count as reps hours is real estate professional hours.

There's maybe we had 3 tax court cases we discussed in the last episode that, that confirmed that education hours do not count.

We want to know why, because you listen to podcasts like this all day, all day long.

Just listen to the podcast, you know, when you're in your car, while you're laying down with whatever you're doing.

But it's just simply not the case because, the task courts in the IRS, They, they, they believe that it's not material to your business.

And, that's, that's, it's just like, like I said, there's 3 task court cases that confirm this and that's, that's, that's end of story.

And if anybody tells you, if any tax advisors tell you or any gurus out there tell you that it does count, then you need to go speak.

I always tell people just to ask for a citation, you know, because, because if somebody can tell you something, then, then they should be able to back it up and we can back it up.

We've got 3 tax court cases that we covered last episode that back it up.

But people that say education research time counts.

as I'm aware, they can't back it up, because I'm not aware of a citation that that supports that that notion.

And I think it's just important for real estate investors to know that they can ask their professionals for citations that you should be able to just like anybody else, like a quality inspection, you should be able to, to have that conversation with somebody.

And because here's the downside, here's the downside.

You don't ask you take their word for it.

They've told you what you want to hear, right?

I can qualify as real estate professional and do freaking nothing.

And then you get audited and then you lose and then you're pissed and you got to go blame somebody.

If you're investing in real estate, you're a business owner.

So at the end of the day, you can blame whoever you want.

You can sue whoever you want, but you're the 1 that's really at fault because you let yourself fall victim to listening to people tell you what you want to hear, not what you need to hear.

We've heard that people will say, so people come talk to us, like we said, we talked to a lot of landlords, come talk to us and they'll go talk to other people.

Then they'll say, well, I was told that CPAs interpret things differently, or I was told that it's a different mindset or something like that.

And the thing here though, is that CPAs interpret the code differently, not because there's different interpretations, at least as it pertains to real estate professional status, but because they're not fully aware of all the tax court cases.

So it's not that there's another way to do it, because real estate professional status, like we were saying in our prior episodes, it's relatively black and white.

And it's relatively black and white because it's so heavily litigated.

We have tons of tax court cases to look at to help us make decisions.

Don't fall victim again to the whole tell me what I want to hear thing, which is oh CPAs interpret it differently and I'll take the position that education research hours count.

After we wrote that 12,000 word guide, middle of 2020, we started helping with real estate professional audits.

Guess what people lose on education research hours, almost every single time.

The IRS auditor will literally throw in their Research time does not count.

You want to challenge me, we're going to tax court.

So don't don't book the education research time doesn't count.

Alright, myth number 6, hitting real estate professional status is easy.

Hopefully, if you've listened to episode 1 and 2, and now you're on episode number 3, this episode, you've realized hitting real estate professional status is not easy.

And anybody selling it to you as easy is full of you know what, so you should be asking for citations and really understanding what you're getting into.

This is a heavily litigated area of the tax code.

You need to make sure that you're crossing your T's and dotting your I's.

And just remember that real estate professional status is not a loophole.

Real estate professional status is not a loophole because section 469 was implemented in 1986 to stop the loophole.

The loophole before 1986 was I'm a rich person earning a lot of income and I can plow my money into real estate, I can accelerate the depreciation and I can offset my income.

1986 came, they added section 469, the passive activity loss rules, and that said all rentals are by default passive.

And now we created 2 buckets of income, passive income and non passive income.

And now rentals were stuck in the passive bucket, while our w 2 income and our business income and our dividends and interest everything else was in the non passive bucket.

Now all of a sudden, we couldn't use rental losses to offset all that income.

So it stopped the loophole basically stopped the tax shelter.

Real estate professional status was later added in 1994 to help people who were full time involved in real estate and couldn't use the rental losses to offset their development income.

So real estate professional status, not a loophole.

It and when you think about it like that, you realize that you start to understand why it's so heavily litigated because people think it's a loophole and they treat it as such, but it's not a loophole.

I think this one's pretty clear, pretty easy.

Reps hours do not carry over year to year.

So if you, what you did last year in 2020, right.

Does not matter for 2021 for the real estate professional status.

Unless you're looking at, you know, 1 of those tests where it takes into account, you know, the last 3 years or the last 5 and the last 10 years.

But at that point, you're not counting hours.

We maybe cut that part out, but the point is the bottom line is very clearly real estate professional status hours do not carry over to your year.

You have to qualify your real estate for real estate professional each year in order to qualify as a real estate professional.

The other thing too, so, sorry, I know that we don't actually have myth number 8 here on our podcast sheet, but I want to go ahead and throw a myth number 8 out because you mentioned it in a prior episode and I was like, we need to talk about that.

And let's say that I buy a rental in November of 2020, but I'm not a real estate professional in 2020.

Let's say that I get talked into doing a cost segregation study on that rental.

So a cost segregation study accelerates the depreciation.

It's gonna create a big tax loss for me, which is good in most cases.

But in 2020, if I'm not a real estate professional, that tax loss is passive.

Now let's also assume I don't have any other passive income to offset that passive loss.

And let's say in 2021, I qualify as a real estate professional and I've got this suspended passive loss on the books.

I cannot use that suspended passive loss in 2021, simply by qualifying as a real estate professional.

So qualifying as a real estate professional, myth number 8, qualifying as a real estate professional does not unlock previously suspended passive losses.

Because the way that that's treated those those passive losses they're treated as a former passive activity IRC section 4 69 F.

And it remains suspended that passive loss remains suspended even though the rental is now non-passive.

So even though you've recharacterized it, you've moved it out of that passive bucket into the non-passive bucket, the loss that was previously created is treated as a former passive activity loss.

It can only offset passive income from your other passive activities, or it can offset the non-passive income that that 1 specific rental generates.

So if I have a rental property that is now non-passive and then it happens to generate positive taxable income which is hard to do with rental real estate, even with great performing rental real estate because of depreciation, then I can tap into that suspended passive loss.

Even though the rental income is now non-passive because that 1 specific property had prior suspended passive losses, I can tap into it.

But it's just important to know that simply qualifying as a real estate professional will not unlock the suspended passive loss.

We had a cost seg firm, I'm not going to name them because they're relatively large, cost seg firm, 1 of the VPs tell 1 of the folks in my course.

So I run a tax course once a quarter and told 1 of the folks in my tax course that qualify, they should do the cost seg now.

They should do the cost seg now because in 2021 when they qualify as a real estate professional they can unlock the suspended passive loss.

Like how, how did these, how these cost seg folks telling people this man, and that was just 1 instance.

I love the cost seg, the cost seg community.

So you gotta be careful who you take advice from.

So now that we kind of demystified some of the myths that are out there among, among, you know, in about the real estate professional status, Let's look at some strategies you can use to actually qualify as a real estate professional.

Let's get down to the good stuff, if you will.

And this is a great way to utilize the real estate professional status and to achieve it.

So that is have 1 spouse qualifies as a real estate professional, because once 1 spouse qualifies as a real estate professional, because if you're married, you're filing jointly.

Now, both spouses are qualified as a real estate professional.

And, you know, the spouse that is the real estate professional can use the losses generated from the rental real estate against the other spouse who's, you know, maybe working in active W2 or business income, right?

So the way this would work is 1 spouse would qualify as a real estate professional completely on their own.

So that means you're hitting the 1 spouse is hitting the 750 hours and more of half their total working time by themselves independently without the other spouse.

Now, as we spoke about in other episodes, that if that does occur, then the second spouse can combine their hours for material participation.

Do not send emails or communicate on behalf of the other spouse or try to frame the other spouse as the real estate professional when you are indeed doing all the work.

So for example, if I were married, which I'm not, if I were married and my wife were to be a real estate professional and I were to do all the work on her behalf and just do it all under her name.

And we see this a lot because typically 1 spouse is really interested in real estate and the other spouse is not, but the spouse that's not interested in real estate is the 1 that's not working or has the ability to qualify as a real estate professional.

And so then the spouse that's super interested in real estate, it's like, well, I'll just send emails on my spouse's behalf and ensure, you know, whatever that, that, that might work under audit, but you get to tax court.

And, it's just, you just set yourself up for failure.

Again, so just to summarize this strategy, because it is a big 1.

If 1 spouse can qualify as a real estate professional, then both spouses, you know, in theory will get the benefits of it or Not in theory, in reality, we'll get the benefits of the real estate professional status.

If you file a joint tax return, this does not work.

If you file a married filed separately return.

So also known as MNFS for all those people out there who care about that type of stuff.

All right, so strategy number 2, time your real estate professional status election.

So literally what we were just talking about with myth number 8.

Maybe I don't take a cost segregation study in that first year where my rental losses are going to be passive.

Maybe I wait until a year where I know I can qualify as a real estate professional and then I do a retroactive cost segregation study.

You can file form 3115 with a 481A adjustment And essentially what you do is you say, oops, I'm going to reclassify all of the components within this building, to their appropriate class lives.

And then I'm going to be able to take all the depreciation that I've missed, including bonus depreciation.

So maybe I'm buying property in 2020 and we're recording this in 2021, but 2020 is still somewhat relevant.

Maybe I'm gonna buy more property in 2021, but I'm working at a full-time job and I'm not gonna be able to qualify as a real estate professional.

My spouse is not interested and I'm gonna take strategy number 1 there, the don'ts to heart because I listened to the Real Estate CPA Podcast.

But So I bought property in 2020, bought property in 2021.

2022, I quit my job in January, February.

So it gives me enough time to still exceed, more than half my time in real estate.

I'm materially participating in my rental properties And I bought like 5 properties between 2020 and 2021.

So in 2022, when I qualify as a real estate professional, I can retroactively cost segregate the 5 properties that I bought in 2020 and 2021.

And I can claim all the missed depreciation, including bonus depreciation on my 2022 tax returns because it's going to create a non-passive loss because I'm a real estate professional and because I'm materially participating in my rental properties.

So time your real estate professional status election.

You don't always need to jump in and do cost segregation studies and accelerate your losses.

Like I said, we don't want to end up with like myth number 8, where you get a bunch of suspended passive losses that we can't do anything with.

So now moving on to strategy number 3 here, another strategy you can use to qualify as a real estate professional is running a separate real property trader business in addition to being a landlord.

Some common ways to do this, again, if we go back to what it takes to qualify, 750 hours in a real property trader business in which you materially participate and more than half your total working time in a real property trader business.

So for example, if you're a flipper, and maybe you're a developer, or maybe you're an agent or a broker, These are business, these are real property trades or businesses.

And if you do these activities on a full-time basis, there's a good chance you're hitting that, that 750 plus more than half your total working time test easily all day long.

And, and, and remember too, that you can group all of your time together and all the real property trades of businesses.

So like Tom was saying, if you're a flipper and a real estate agent, well, you get to count your time flipping and real estate agent brokering together for the purposes of hitting the 750 and more than half your time.

And you know, that makes it a lot easier to hit that 750 hour test because, you know, these are activities that you're probably doing on a day-to-day basis.

And if you're full-time in those activities, so that gets you to that 750 hour point or in more than half your total working time.

But as we discussed in previous episodes, that's not all, you need to also materially participate in your rental activities.

So basically what you can do there from there is because you already hit the 750 hours mark.

You have 1 of the 3 material participation tests on your rental properties.

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REPS 03: Common Myths and Strategies for Investors Qualifying as a Real Estate Professional