Real estate is tricky and is usually treated much different than a typical business. This is just one Blog Post and Podcast Episode in an entire guide we put together on real estate taxes.

If you have not checked out our other content around real estate taxes, do so now by visiting: The Ultimate Guide to Real Estate Taxes

Last week we talked about real estate losses and some strategizes to utilize passive losses. If you have not checked that one out yet, do so now. This week we are going to be expanding on two of those strategies which are active investors and real estate professional statuses.

What Is An Active Real Estate Investor?

If you "actively participate" in managing a rental property you can utilize up to $25,000 in rental real estate losses to offset other income (including ordinary income). With that being said there are some income limits and requirements you need to be aware of in order to be considered an "active participant".

Lets talk income limitations first. If your AGI (adjusted gross income) is under $100k you qualify for this requirement. The deduction starts to phase out for income between $100k and $150k and once your AGI is over $150k it is completely phased out. 

Next you need to "actively participate" and basically this is really easy to meet. The participation does not need to be regular, continuous, or substantial involvement. It can be something as simple as making management decisions or hiring contractors to provide services on the property.

Lets summarize everything:

• If your income is below $100k and you "actively participate" in managing your rental, you can deduct up to $25,000 in real estate losses against other income (including ordinary income).
  • This starts to phase out between income of $100k and $150k and is completely phased out once you income tops $150k.
  • You first need to net this against other passive income before using against ordinary income.
  • If you are married filing separately, this allowance is not available for you.
• Any losses that are unable to be used are carried forward!

Basically if your income is under $100k you should be shooting for being an active real estate investor because it is so easy to achieve and allows you to offset your other income with your passive losses.

If you phase out then you will want to explore the power behind being a real estate professional.

What Is A Real Estate Professional?

If you qualify as a real estate professional you are able to offset ordinary income with your rental losses. This allows you to use your full loss, not just limited to the $25k that we mentioned above. In order to qualify as a real estate professional you need to materially participate and then meet two further tests.

To be considered material participation in one activity you need to meet 1 of 7 tests the IRS has. There are two main tests that we see most people target, which are:

• You participated in the activity for more than 500 hours.
• You participated in the activity for more than 100 hours during the tax year, and you participated more than any other individual (including individuals who didn’t own any interest in the activity) for the year.

If you meet the material participation test in one or more activities you then need to meet the two real estate professional tests:

1. You performed more than 750 hours of services during the tax year in real property trades or businesses in which you materially participated.
2. More than half of your working hours for the year must be in your real estate in which you materially participated.

One thing to understand with material participation is that it is separate for each activity. However, you do have an option to elect to treat all of your real estate activities as a single activity. This would be helpful if no single activity meets the 750 hours test for the real estate professional or if you don't meet the material participation test in an activity that you want to use the losses for.

It is important to understand that you must both materially participate AND meet the real estate professional tests in order to qualify as a real estate professional.

Qualifying as a real estate professional can be complex and there are certain things you need to do to ensure you are documenting everything properly. Just be sure to take this seriously and you are making sure everything is setup properly.

Active Investor and Real Estate Professional Example and Summary

Remember from previous topics discussed, rental activity is typically going to be a passive activity which means any losses from rental activity can usually only offset other passive income (not ordinary income).

In this blog we discussed two options where you can use a rental loss to offset other types of income, as long as you qualify. 

Lets go through an example to put this to practice.

• Assumptions
  • W2 Income: $90,000
  • Rental Losses: ($70,000) - Due to High Initial Depreciation and Normal Operating Expenses

If you actively participate in the rental activity (like we mentioned above) you would be able to take $25,000 of your losses to offset a portion of your $90k W2 income with the remaining amount being carried forward. This means that you would only need to pay taxes on $65,000 of your W2 income. Note, if you did not actively participate you wouldn't be able to use the passive losses until you had passive income. Although, if you qualify we recommend everyone take advantage of this.

Now, lets say you qualified as a real estate professional and materially participated in the activity. You would be able to take the full $70k loss against your W2 income, meaning you would only pay taxes on $20k.

As we talked about in previous Blogs and Podcast Episodes, often times real estate in the beginning years will have a positive cash flow (money in your pocket) but show a loss on paper due to high depreciation. Utilizing real estate is a great way to cut your tax bill but you need to make sure you are doing it correctly and documenting everything properly.

Again, this is just one Blog Post and Podcast Episode in an entire guide we put together on real estate taxes.

If you have not checked out our other content around real estate taxes, do so now by visiting: The Ultimate Guide to Real Estate Taxes

We also have a full section in our Tax Minimization Program specific to strategies around rental properties!