← Tax Smart Real Estate Investors Podcast
Tax Smart Real Estate Investors Podcast
306. Can You Pull Off REPS in 2025 (And Save BIG)?
00:29:43
In this episode, Thomas and Ryan break down the e…
Loading summary
Transcript20 lines
- [00:00]
A
You're now listening to the Tax Smart REI Podcast, the number one tax podcast for real estate investors, your source for.
- [00:07]
B
All things real estate accounting and tax. Here we reveal our secrets that can save you thousands in taxes, streamline your accounting process and help grow your business. Stay tuned to hear insightful interviews with industry experts, successful real estate investors and current clients on what strategies they use to grow their business and how they steer clear of Uncle Sam.
- [00:33]
A
Welcome back to the Tax Smart REI Podcast. In today's episode, we're gonna be talking about the real estate professional status, also known as reps, and how you can use it to save substantial amounts of money on your taxes if you're able to or your spouse is able to work full time in real estate. It's probably one of the most powerful tax strategies next to the short term rental loophole. So before we dive right into the real estate professional status, wanted to make one quick update. And this is the last update I'm gonna make unless something is permanent with this, the Corporate Transparency act, the 2024 CTA is now back in effect. If you remember on our last episode, I believe it was, I mentioned briefly that it was suspended, it was paused essentially by a court in Texas. And over the holidays it is now put back into place and the due date now is January 13th. So this episode's gonna be coming out on the 7th of January. That gives you about six days to go ahead and comply with it. My two cents on it right now is just go and comply with it, period. End of story. It looks like it's going to be here. It got reversed twice or it got banned or, you know, got stayed twice and now we're back here. That's the last thing I'll say on it. But last week on our last episode, we went through the short term rental loophole and how you can save up to five, six figures when you invest in short term rental properties. And that's great if you work part time. It's great if you love the short term rental market. But what if you own long term rental properties, Right. How can you use long term rentals to reduce your taxes? And that's what we'll be talking about today with real estate professional status.
- [02:01]
C
Yeah, like Tom mentioned, just to say it again, the short term rental loophole is for short term rentals.
- [02:07]
B
Right.
- [02:08]
C
It's in the name. I like to kind of reference that when I talk to people just to make it seem as obvious as possible. And then real estate professional status is for long term rentals for maybe some Context as we move into discussing this further, this really came out with the tax Reform act of 1986. So really before that, and then we'd like to get into kind of what does this mean for us and the specifics. But 1986, big tax reform act. So before that we had people like really high income earners, physicians, high income attorneys, you know, people like that who are basically using losses from rental properties and offsetting their physician, you know, income, things like that. And it was kind of like, hey, they found through this data, some sort of survey that the IRS did. Hey, these really high income doctors are actually effectively paying very low tax because of these losses from real estate offsetting their income. And so they basically were like, okay, we need to change this. And so we've got these buckets of passive, non passive. And really the big change here for real estate investors was all of those losses from rental properties specifically then became by default passive. Okay, so this was kind of the new part before it was like everything's kind of non passive as far as I'm concerned. And now we've got this by default comment that all rental properties were considered passive. And so some time went on, right? And then I think the real estate professional exception, if we want to call it that or strategy really came out a few years after this tax reform act came out. And so we'll start moving into that now. But really what it's going to do is move rental properties again, specifically long term rentals that were by default passive and now move them or transition the character to now being considered non passive. And when we've done that now, now those losses can offset your other non passive income. So what is that? For example? W2, right. I mentioned a physician, maybe a high income attorney. You've got W2 income, right. It could also be you're a business owner, you've got some business profits, non passive income, things like that, or portfolio income. So that's really what it's doing. It's really just the ability transition from the passive bucket into the non passive bucket, those long term rental losses.
- [04:13]
A
Absolutely. One thing I'll throw in there before we kind of break down some of the requirements and some of the things you need to qualify for the real estate professional status is that this usually includes quote unquote midterm rentals. Right. A lot of people in the short term rental space sometimes come across, you know, the ability to rent their property from 30 to like maybe 90 days. Traveling nurses, travel, doctors, digital nomads, all that good stuff. There is A market for these midterm rentals. It's important to note that as far as the tax code is concerned, there's no such thing as a quote unquote midterm rental. All right? What you have is you have short term rentals, on average stay seven days or less. And we're not going 30 days or less. If you provide substantial services or you have a long term rental property, or you just have a rental property, that's it. There's no in between. So when we're talking about the real estate professional status here today, note that that probably means like 99% of the time you're midterm rental. Okay, so how do you qualify as a real estate professional? Right. How do you get these benefits? Well, you need to meet two criteria here. You need to spend more than 750 hours in a real property trader business. We'll talk about what those are in a second. And two, this needs to represent more than 50%. Okay. More than 50% of your total working time. Now I want to point this out here because this is an important part. If you are a full time W2 employee, the IRS considers you to be working roughly 2,000 to 20, 80 hours per year. That means to spend more than 50% of your total working time in a real property trader business, you need to work 2001 to 2081 hours in real estate, which is roughly 81 hours a week for virtually the entire year. The IRS knows that's basically not possible for all intents and purposes. So is the task courts, and they often agree with the IRS here. So the way you can kind of get around this is by A, either using short term rental loophole because you do that part time, or B, having your spouse qualify. Right. If one spouse qualifies, then both spouses get the benefit of the real estate professional status. If you're filing a joint return. And key thing here, if your spouse is qualifying or you're qualifying for the real estate professional status, you cannot combine hours for the 750 hours. One spouse needs to meet this by themselves. So that's how you qualify for the real estate professional status. Do we want to go into a little bit about what the real property trades or businesses are and how that kind of all fits in here?
- [06:44]
C
Yeah, so some of the. Just a brief list here. There's 11 in total. 11 real property trades or businesses. I'm just going to name a few of them. I like to actually break down the 11 into three different categories. The first one is the development, construction, and conversion. So I kind of picture someone with like a hard hat, right? The physical real estate itself getting built. Okay, that's kind of category one. Category two is kind of the, the transactional person. Right. You've got the acquisition, the brokerage and the leasing. Right. That's kind of the transactional piece of buying, selling, thinking like a realtor. Okay. And the third category is kind of the management. Right. You've got the rental portion, the operations of real estate or the management. Right, Specifically in there. So that's like the person who's overseeing, making decisions, bringing in new tenants, that's a property manager. Right. So you basically got the general contractor, you basically got the realtor, and you've got the property manager. That's an oversimplification, but trying to make this simple framework for people to really understand. So there's 11, but that's really like the simple way of breaking down. Those are just the real property trades or businesses. And the one common misconception here too is basically people think, oh, I'm generally in real estate, I must meet this real property trader business. I have seen people writing on LinkedIn. They're not CPAs, they're not EAs, they're not experts in tax, and they put out really terrible content to say, oh, lenders will qualify for real property trader business. Very frustrating. I've almost reached out to a couple of them. So you just need to be careful what you're reading out there. But that's just one example of like, what would not qualify for this.
- [08:16]
A
Yeah, right, right. And let's drill down to that a little bit because I think there's some strategy in here for people who are listening and how you can actually know strategically get involved in different real property trades or businesses. And to kick this part off, like Ryan said, mortgage brokers and lenders are in the business of lending as far as the IRS and task courts are concerned and they are not considered a real property share business. So let's just put that off to the side. There's detailed explanations on why that is, but just know that it's pretty clear cut that they don't count. All right, so what are some strategies here? Right, so sometimes you might be like, say you're a full time real estate agent or broker, right? You're a prime candidate for the real estate professional status. If you're working on a 1099 basis, you've already probably. Or you know, you're, if you're doing it full time, you're likely meeting that 750 hour and more than half your total working time requirement. So that's great. In that case if you go and acquire rental properties and self manage them, then you're gonna be able to take the losses from your rentals and use em to offset your income from your agency or from your commissions that you're generating as an agent or broker. So that's fantastic. And some people say, you know, you are a married couple, one spouse, maybe they have a full time job that's high income or a business that they're running that's not real estate. If one spouse can qualify as a real estate professional like we said before, then both qualify. So one strategy that people often use is they'll become a real estate agent in addition to acquiring rentals. And when you become a real estate agent, it's not merely getting your license and saying hey great, I'm a real estate agent does not qualify. You remember this is an hourly test. 750 hours and more than half your total working time. So if you're going to become a real estate agent in to help you get to this criteria to qualify then you need to make sure that you're actually out there generating commissions. You're an agent, you really are a real estate agent. You're not just one in name only. Okay, so that's just something to keep in mind there. One last thing I'll comment on that. You do not need to be a real estate agent to qualify. That's a common misconception, is like okay, I need to be a real estate agent to be a real estate professional. This is not the case. So that's one strategy, real estate agents and brokers. Another one is in addition to acquiring rental properties, you can become a wholesaler or, and, or a flipper. Right? Both of those kind of fall under those categories that Ryan mentioned. And that can also help you get to 750 hour requirement. With 2024 officially in the rearview mirror, now's the perfect time to start planning for how you're going to maximize your tax savings in 2025. With major tax changes looming under the new administration and IRS audits on the rise, navigating the tax code alone is now riskier than ever. Whether you're leveraging the short term rental loophole, claiming the real estate professional status, utilizing passive losses, 1031 exchanges or anything in between, our expert team of tax advisors at Hall CPA has your back. We'll help you uncover hidden opportunities and avoid costly mistakes that could put you at risk during an audit. With potentially tens of thousands of dollars of tax savings online. Why wait? Visit www.therealcpa.com podcast to request your free 30 minute to Discovery Call today. Again, that's www.therealcpa.compodcast for a free consultation. Let's help you ensure you keep more of what you earn in 2025. That's all for now and we'll dive right back into today's episode.
- [11:31]
C
Two things I wanted to mention there too. Some of you listening, you're not currently in a real property trader business and you're thinking of ways to get into that, what Tom just mentioned, they're great examples, right? And easy ones sometimes compared to like becoming a general contractor and you, you know, being a property manager. Those can be complex and difficult and so can be becoming a realtor. Don't, don't get me wrong, but that is a common way where we've seen, you know, two spouses and maybe one spouse is a high income W2 earner, the other spouse is currently part time or something or like a homemaker and they're like, what should we do? And the advice oftentimes is, well, are you interested in buying, selling houses and becoming a realtor? That's one option. But the other thing I just want to comment on too is there's some of you listening who are currently selling in these real property trades or businesses, right? So some of you listening maybe are realtors or your general contractors or whatever. And again, you got to make sure that you first and foremost, you fall into that 750 hours more than half your time. But the second thing we're going to get into step two, which is material participation here in a bit. But the common misconception I hear just from friends and networks and things like that, or new clients is hey, I'm a real estate agent, so I qualify for this. No, you don't. The first part, yes, you could. 750 hours more than half your time. But where we're going to go next with this is the material participation in your rental properties. That's like the completion of really making those losses from your long term rentals go from the passive bucket by default now into the non passive. So just wanted to comment on that as we kind of transition into talking about that in a minute. It's not just, hey, I'm a realtor, therefore I meet this. Maybe you meet the first step that we just went through. Okay, but it doesn't necessarily mean, oh, you're done, we've got more to discuss here.
- [13:08]
A
Yeah, no, That's a, that's an excellent point and thanks for clarifying that there. Because to your point, yeah, if you work in one of these other real property trades or businesses, that's not a rental business, you can, like Ryan said, Hit 750 hours. But all that that does is now you are a real estate professional. However, to take the losses from your rental properties, you still need to materially participate in your rental properties. So if you got the 750 hours and more than half your total working time only on a rental business, then congratulations, you kind of hit the material participation tests on the way to that 750 hours and you're good to go. But again, if you're agent, you're wholesale, you're flipping, you're in one of these other businesses and you have rental properties, if you go and hire a property manager and they handle virtually everything for your rental business, then you're probably not materially participating and that could be problematic. Meaning your losses could still be passive on your rentals despite the fact that you are a real estate professional. Professional. So I guess let's dive a little bit into material participation. So if you tuned into our last episode or heard any of our other episodes, we talked about reps or short term rentals, you probably already know what material participation is. But if you're new, maybe tuning in for the first time, or you just need a refresher, there's usually going to be three tests that you are going to look at to meet the material participation requirement. The first one is going to be you spend more than 500 hours on the activity and we'll get more into activity in a second with grouping and all this stuff. But more than 500 hours. Now again, if you met the 750 hour requirement only on your rentals, you already hit the 500 hour test. So you're good. Okay, that's one test and that's the 500 hour test is usually the best test, especially as you scale. But the other test is you do substantially everything yourself. So you're like a one person show with very little to no outside help. The third one is you spend more than a hundred hours and nobody spends more time and you know, individual, so no third party spends more time than you. So those are the three tests you want to make sure you met at least one of those three tests on your rental activities in addition to meeting the 750 hour and more than half your total working time requirement.
- [15:13]
C
Yep. And like Tom said, there can be overlap there where you could have like you said 750 hours in your rental properties. And we'll dive into in a little bit, like what activities count, because there's even nuances there. But basically, you could have 750 hours in your rentals and that would simultaneously qualify for that 750 hours and more than half your time test. There is overlap there. Just one distinction I like to make usually is that the time that you spend, for example, being just a realtor. Right. Say you're in that business, you've got a thousand hours there over the course of the year. Obviously that's different and separate from material participation in your rental properties. So there is overlap. You've got to kind of understand the nuances there. Where does it overlap? And it's really all about the time in your rental properties. Okay. That's really, really important. And yeah, I don't know if Tom mentioned this, but yeah, there are a total of seven material participation tests. We're just hitting the three most common that we've seen and kind of usually applicable to this test.
- [16:10]
A
Yeah. So we're going to summarize all this towards the end of the episode. So if you're kind of like trying to put it all together, don't worry, we'll, we'll, we'll bullet point this for you at the end. But there's something else I wanted to mention before we kind of get into what actually counts as material participation. Have to remember the grouping election. Okay. So when you qualify as a real estate professional. Great. Now, we just talked about the material participation test. Now, theoretically, you have to meet one of these material participation tests on each one of your rental properties. So if you have 10 rental properties, you have to meet one of those three tests on all 10, unless you make a grouping election. So once you qualify as a real estate professional, you can make the election for tax nerds out there or people who need to tell their CPAs or whatever the case is. It's under section 1.469g. Okay. That's the code section. Sometimes they call it the Dash 9 election or the Reps grouping election. Basically, you make this election your tax return, and you're going to treat all of your rental activities as one activity. It's like you have 10 rentals now. They are all just treated as one for the purposes of material participation. So that means that you only have to meet one of those three tests now across your entire rental portfolio, which makes it a lot easier than having to meet one test on each and every one of your properties.
- [17:31]
C
Yeah. So if you can now group that. And as you're probably listening to this too, you're probably like, oh yeah, it's obviously going to be easier for me to accumulate enough hours the more properties you get. Right. And so I'll just make a quick comment explicitly on that. If you've got one long term rental, it is going to be very difficult to meet real estate professional status. The more that you've got, the more time you're involved, the more that you are managing the property instead of having a property manager, just the easier this is going to be realistically. Okay, Right. And now maybe, Tom, as we talk about this, we could get into the specifics of what types of hours count.
- [18:03]
A
Right. So not every second you spend on your rental properties counts towards the real estate professional status. The activities that or the time that generally counts is going to be the time you spend in the day to day, quote unquote, the day to day operations of your property and forgot who came up with it. But a good litmus test for this would be if your activities are not impacting the operations of the property, then it's probably not material to your business. So some quick bullet point list of act time that does typically count and we'll get into time that doesn't count is going to be listing your property for rent, showing your property tenants, doing tenant reviews, tenant screenings, credit checks, that type of thing, inspecting the property, handling repairs and maintenance and capital improvements yourself, or coordinating other people to do these types of activities. If you do get to a certain point in scale, there might be a point where you do have property managers and you're still actively involved. Time spent coordinating with them can also count. So just think like evictions.
- [19:07]
C
So I've got like a kind of a short list that I talk through usually and I kind of picture it as you've got the hammer, kind of all the physical things at the property, like you said, capital expenditures, repairs, improvements like that. It could also be, you know, even like cleaning the units if you're doing any sort of turnover there. If you're physically maintaining the grounds, like maybe you're cutting the grass or you've, you know, in a place like Minneapolis like me, where you're shoveling the snow, things like that, or like purchasing supplies for any repairs and improvements or inspecting the property. Right. So that's kind of like what I see as like the physical work. Like usually you're there and usually you're doing something like swinging a hammer. And then the other one that you had kind of started with Tom is like more of the management type. Right. So that is like you said, showing the property to prospective tenants, placing the ad online, maybe it's apartments.com or Zillow, whatever it is, taking those applications and then doing the screening yourself, negotiating leases. Right. Communicating with tenants as they have questions or you're trying to finalize the lease, collecting rents or evicting tenants. Right. So all of that is kind of the management side and that's kind of like the soft stuff. Whereas like the first part, right. The swinging the hammer, that's like I'm physically there, nailing stuff in. That's like the physical property itself. Yep. Those are like the two main categories day to day.
- [20:17]
A
Right, Right. And to a lot of people listening out there, this sounds like work. Right? Right. And that's because it is work. The real estate professional status is kind of put into place for people who are full time in real estate, actively working in, in this industry. Right. It's not meant to be passive. Right. I know a lot of investors jump into real estate. There's all different types of reasons people get into real estate. Sometimes for the tax benefits, sometimes it's for passive income, to build wealth, so on and so forth. A lot of people who jump in for, who want it to be passive often are shocked to hear this. Right. If you end up hiring a property manager, if you go buy a turnkey property out there, you hire a property manager and you're not really doing much but reviewing financial statements and doing like, you know, sign offs and stuff like that. Little things. That's probably not going to count as material participation underneath the tax code. Those are probably investor level hours and that time won't count. So when you're looking to qualify as a real estate professional, either you, if you're going to qualify or your spouse, they're going to qualify, need to basically look through the lens of a property manager. That's pretty much what you become when you're looking to qualify for the real estate professional status and materially participate in your rental activities. So I think we can move on for that for now. One thing I will note here is just like the short term rentals, you do need to document your time. Documentation of your time is going to be crucial in the event of an audit to prove that you actually met these requirements. This isn't criminal court where you're innocent until proven guilty with the irs. It's on you to prove that you met these requirements. So again, people track their time with spreadsheets, with Clockify, with toggl These are time tracking applications. There's a few others out there, but you want to make sure you're tracking your time. You want to make sure you're doing it proactively. And it's not something you want to neglect because big tax savings can be in play here for you. And if you're not taking this seriously, if you are audited, you know, you could be facing back taxes, penalties, and interests. We've seen it before. There's dozens and dozens of task court cases. We reviewed some of those here on the show in the past. And you don't want to be stuck in that position. So just do your time log if you're looking to qualify for this.
- [22:23]
C
Yeah. And the bullet points of, you know, what's included on that time log. If you're thinking like a spreadsheet, which I'd say, you know, my working with people, probably 80, 90% of people are just using like a spreadsheet using, you know, something just on Google Drive that you can access. If you're driving to your property, you're getting home and you just want it quick on your phone. You want it to be accessible and convenient. But really there's like five things. Okay, so number one is just the date, right? When did you do this? Okay, number two is how much time did it take you? Hour, 15 minutes, 30 minutes, whatever it is. Third is just a description of what you did, Right. Talk about what you did, Right. Hey, I fixed this toilet at this unit. Great. The fourth thing is who did the work? Right. If you're married, you want to consider was it you or your spouse or who did it? Okay. And then fifth, if you've got multiple properties, is which property. That's really the five simple things. So when I've explained it, it's been when, how much, what, who and where. That's really it. Like, if you want to simplify your spreadsheet, that's really the questions that we're answering. That's like baseline of what you want. Some people will even take it as far to say, I'm going to even do like pictures. Picture is worth a thousand words. That can be really helpful. I don't think I've seen or read anything or no one's notified me that that's necessary documentation. But I think it's going to be hard to say that that's, you know, difficult to say. I wasn't there, I wasn't doing something because the courts have kind of called that out and said, hey, this doesn't make sense. How were you there for that long. We don't know how long, like what was going on, all those things. So a picture isn't terrible, but we don't think, I don't think that's, that's necessary. So just as you think about kind of what's the bullet points there of what needs to be there, those are like the five key items that you.
- [24:04]
A
Should be documenting, you know, for sure. You definitely want to make sure you have those on your timesheet. Let's just take a quick second to summarize and we'll touch on any other points that may be relevant to this episode for people who are thinking about the real estate professional status. All right, so all rentals are passive by default, meaning the losses from your rental activities cannot offset your W2, your active A business income or other non passive income. The way around that is to qualify for high income earners is to qualify as a real estate professional. Real estate professional status allows you to take your rental losses and make them non passive so they can offset these other income to qualify. And you spend more than 750 hours and more than half your total working time in a real property trader business. Given these requirements, all the court cases out there on this, it's virtually impossible for you to qualify if you have a W2 job. So your spouse might be able to qualify. And if your spouse is going to qualify or you're going to qualify, whichever one of you it's going to be needs to meet these requirements by themselves independently. With the short term rental loophole, which we discussed on the last episode, you can combine your hours with your spouse for Those tests here, 750 hours that needs to be met by you or your spouse alone. So once you met those two requirements, you're now a real estate professional. Great. But you have to still make sure that you materially participated in your rental activities by meeting one of the three tests, 500 hours or 100 hours, no one else spends more time than you. Or you do substantially everything yourself. If you're working as an agent or a broker, or you're in construction, or you're fixing and flipping, this is more so critical for you. If you've got that 750 hours only on your rentals, you already got the 500 hour test on the way there. So you're good. But that in a nutshell is how you qualify as a real estate professional. One more thing I think we didn't discuss here today is how you really maximize the benefits, right? So great. Now your rentals are non passive how do you really take advantage of that? Well, you use cost segregation. We're not going to go through a total tear down of a cost segregation today. But cost segregation studies, they break down the components of your property into various class lives, right? Because your long term rental is typically going to be depreciative 27 and a half years if it's a residential property, or 39 years, it's commercial, like a retail or an office building, something like that. But not all the components have a 39 year class life within that property. So cost segregation comes down and breaks it down. And basically you combine that with bonus depreciation. And bonus depreciation says that property with a depreciable life or class life of less than 20 years can be depreciated much faster. This year, in 2025, as it stands today, as of this recording, it is 40% bonus depreciation, meaning you're going to be able to depreciate 40% of the value of these components in the first year. However, we know that the new administration wants to and there's bipartisan support for this, to extend 100% bonus depreciation or bring it back. And it's widely expected that that's going to happen for the 2025 tax year. So I would not be surprised if we see 100% bonus depreciation come back this year. And if it does, that's going to make this strategy, the real estate professional status and the short term rental loophole, which we discussed again last episode, even more powerful than they are right now. But as it stands today, when you combine the real estate professional status or the short term rental poll with cost segregation and bonus depreciation, it's probably still, or I don't even want to say probably, it is still one of the most lucrative tax strategies if you're looking to reduce taxes on your W2 income or your active business income by far. All right, so I think that's about it for today. We covered basically the real estate professional status 101. What you need to know if you are looking to reduce taxes using real estate. This strategy we discussed again today and last week's the short term rental loophole. The top two strategies for doing that, if you are interested in and you do need assistance in navigating this and look, these are complex strategies. There's a million one questions you could have and how to properly apply this to your situation. We are accepting clients. Now is the perfect time to start tax planning for 2025. You can request the initial discovery call. We'd love to learn more about your situation. How we can help by visiting www.therealeestatecpa.com podcasts again at therealestatecpa.com podcast you request a 30 minute consultation. Also, Ryan, want to throw this in here. We do have a guide to the Real Estate Professional status. It's however many words, it's a very, very thorough document and you can find that by going to therealestatecpa.com go under the resources tab, click Ebooks and Guides and you'll be able to see the Real Estate Professional status for Landlords and it is probably one of the most comprehensive resources available on this topic. So if you are interested, go ahead and check that out. That's it for this week's episode and we'll catch you on next week's episode of the TaxSmart REI podcast.
- [29:01]
B
Thanks for listening to today's show. If you enjoyed the show, please find us on itunes and leave us a review. You can also email us@contactherealestatecpa.com with any feedback or topic suggestions. We are always taking on new clients and with the new tax law is in play. You really don't want to navigate this alone. Let us help you save money on taxes with your accounting and CFO needs to become a client. Navigate to our client page@the realestatecpa.com and fill out a web form with as much detail about your situation as possible. Thanks so much for listening. Have a great rest of your week.