Real Estate Professional

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Generally, rental activities are passive activities whether or not the taxpayer materially participates in them. However, if he/she is a real estate professional as set forth in IRC Sec. 469(c)(7)(B) Sec. 469. Passive activity losses and credits limited, rental real estate activities in which the taxpayer materially participates are not considered passive. For this purpose, each interest the taxpayer has in a rental real estate activity is treated as a separate activity unless he/she chooses to treat all interest in rental real estate activities as one activity. (See Schedule E instructions for more details).

Closely held corporations can also qualify as real estate professionals if more than 50% of the gross receipts for its tax year came from real property trade or business in which it materially participated. IRS Publication 925

The taxpayer will be a real estate professional, if the taxpayer meets these two requirements:

1. More than half the personal services performed by the taxpayer in all trades and businesses were performed in real property trades and businesses in which he/she materially participated.

2. The taxpayer performed more than 750 hours of services during the tax year in real property trades or businesses in which the taxpayer materially participated.

Do not count personal services the taxpayer performed as an employee of a trade or business as services in a real estate business unless he/she was at least a 5% owner of the employer. If the taxpayer is filing a joint return, the spouse's personal services should not be counted. However, a spouse's participation can be counted for the purpose of meeting the material participation test.

A real property trade or business: develops, redevelops, constructs, reconstructs, acquires, converts, rents, leases, operates, manages, or brokers real property. IRC Sec. 469(c)(7)(C) Sec. 469. Passive activity losses and credits limited and IRS Publication 925. Reg. 1.469-9(d) Treasury Regulations, Subchapter A, Sec. 1.469-9 provides tests to determine if a taxpayer’s business is considered being involved in real property trades or business. As a general rule taxpayers who only participate in trades or business that only involve real estate transactions are not considered to have materially participated in a real property trade or business. As an example an attorney or accountant who specializes in real estate would not be involved in a real property trade or business. The same holds true for someone involved in a real estate mortgage business. It seems that none of these individuals could treat rental losses as nonpassive even though most of their time involves real estate.

Remember even though most of the time having activities treated as nonpassive is to the taxpayer’s advantage, there are situations where leaving an activity as passive is a better strategy. An example is if the taxpayer’s rental activity is generating taxable income and it is believed it will do so for the coming years and the taxpayer has other activities that are passive and generating loss, it might be better for the taxpayer to leave the rental activity as passive and take advantage of the passive losses.


SELF-EMPLOYMENT INCOME

In general, rental income/loss from investment real estate is not self-employment income/loss. This is the general rule, whether or not the taxpayer/owner/landlord is a "real estate professional" under the Section 469(c)(7) rules.

Here's what IRC section 1402(a)(1), defining "net earnings from self-employment," says: "... there shall be excluded [from self-employment income] rentals from real estate and from personal property leased with the real estate ... together with the deductions attributable thereto, unless such rentals are received in the course of a trade or business as a real estate dealer ...."

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