One of the decisions I need to make this year is whether or not I plan to file taxes as a “Real Estate Professional.” For those not familiar, let me take a minute to explain the advantages of claiming professional status:
If you invest in real estate part time (not a professional), you may be able to deduct a portion of your RE losses on your tax return. If your adjusted gross income (AGI) is less than $100,000, you can deduct up to $25,000 per year in RE losses against that income. This benefit phases out (incrementally drops from $25,000 to $0) if your AGI is between $100,000 and $150,000. And if your AGI is over $150,000, you don’t get to take any RE losses in that year. That said, any losses can be â€œcarried overâ€ and used in subsequent years, based on the same AGI criteria.
The benefit to declaring “Real Estate Professional” status is that all real estate losses can be claimed against income in that year, without limitation based on AGI.
So, if a part time investor (who makes less than $100,000 per year) racks up $75,000 in real estate losses in 2008, he can deduct $25,000 of those losses in each of 2008, 2009, and 2010. If he continues to rack up losses in 2009, 2010, etc, those losses will also have to be carried forward. In contrast, a Real Estate Professional in the same situation can deduct the full $75,000 against AGI in 2008, and can do so with the additional losses in subsequent years.
The big question for me is whether I would even qualify for Real Estate Professional status in 2008. The IRS rules for claiming this status appear to require two criteria be met in the given tax year:
- More than half of the professional hours worked throughout the year must have been devoted to material participation in real estate activities;
- More than 750 hours of material participation in real estate activities in the tax year being considered.
While I will definitely be spending more than 750 hours on my real estate business this year (and this will be more time than I spent on any other professional activities), the key is that these hours qualify as “material participation.” I’m fairly certain that the â€œresearch and learningâ€ activities are not considered â€œmaterial participation in real estate activities,” so activities such as creating my business plan, incorporating my business, writing this blog, etc, will not qualify. But I imagine things like searching for properties and getting familiar with the local demographics might be. And certainly all the work I do specific to my properties (acquisition, managing contractors, finding materials, etc) will qualify.
So, the question remains, exactly how is “material participation” defined and will I have 750 hours of material participation this year. Just to be safe, I’ve started keeping a journal of my daily activities related to the business. This includes each task I perform, the number of hours I spend on each, and the number of miles driven (to use as a tax deduction). I guess I’ll hand that spreadsheet over to my CPA at the end of the year, and let him decide if I qualify or not. Better yet, I’ll probably set up an appointment with him in the next couple weeks to get ahead of this issue, in case there are things I can do differently to enhance my tax benefits in this area.