Hi Everyone
i have a ? about material participation on your the tax return , they ask if i am a realestate professoinal, i do spend more then 750 a year on my proporties and this is my only job but it is with collecting rents , fixing things and driving, finding people to rent proporties, also if i am a realestate pro do i have to spend 750 per proporty or is it 750 total hours, would i be consider a relestate pro by the irs if i dont have a license
thanks for all your help
the only difference “real estate professional” makes is that your losses are not limited to $25k if you are a pro. (the activity is not passive)
that’s 750 hours total in the real estate business
material participation is defined as:
You participated in the activity for more than 500 hours.
Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who did not own any interest in the activity.
You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who did not own any interest in the activity) for the year.
The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you did not materially participate under any of the material participation tests, other than this test.
You materially participated in the activity for any 5 (whether or not consecutive) of the 10 immediately preceding tax years.
The activity is a personal service activity in which you materially participated for any 3 (whether or not consecutive) preceding tax years. An activity is a personal service activity if it involves the performance of personal services in the fields of health (including veterinary services), law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital is not a material income-producing factor.
Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the year.
For most rental property investors, it would be better in the long run if you are not a real estate professional.
By converting passive losses to active losses, the real estate professional can deduct rental losses without regard to the limitation imposed by the passive loss allowance. On the other hand, if the real estate professional’s rental income is a net positive, then it is also subject to self-employment income taxes.
Converting passive losses to active losses also means that profit on the sale of the property becomes active income – no capital gains tax treatment.
Just my point of view.
Hey Dave, I think rental income is always passive, even if a real estate professional. it only removes the loss limitation.
the sale of rental property is always capital.
Mark,
I conclude from IRC Section 469 that a real estate professional is not allowed to have passive income from rental property, but instead, passive rental income is converted to active income (and consequently net passive losses are converted to active losses).
If this is the case, then wouldn’t the real estate professional’s rental property become the same as inventory in an active real estate business or trade with sale profits taxed as ordinary income rather than capital gains?
I would be interested in your take on this.
Here is the Section 469 language:
§ 469. Passive activity losses and credits limited
(c) Passive activity defined
For purposes of this section—
(1) In general
The term “passive activity” means any activity—
(A) which involves the conduct of any trade or business, and
(B) in which the taxpayer does not materially participate.
(2) Passive activity includes any rental activity
Except as provided in paragraph (7), the term “passive activity” includes any rental activity.
(7) Special rules for taxpayers in real property business
(A) In general
If this paragraph applies to any taxpayer for a taxable year—
(i) paragraph (2) shall not apply to any rental real estate activity of such taxpayer for such taxable year,
(B) Taxpayers to whom paragraph applies
This paragraph shall apply to a taxpayer for a taxable year if—
(i) more than one-half of the personal services performed in trades or businesses by the taxpayer during such taxable year are performed in real property trades or businesses in which the taxpayer materially participates, and
(ii) such taxpayer performs more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates.
we are both partly correct. The income is active (not passive) but it is considered “unearned” income, and not subject to SE.
Self Employment Taxes are covered in Code Section 1402(a), which taxes net earnings from self-employment. Treasury Regulation 1402(a)-4 clarifies the Code Section and states "(a) In general. --Rentals from real estate and from personal property leased with the real estate (including such rentals paid in crop shares) and the deductions attributable thereto, unless such rentals are received by an individual in the course of a trade or business as a real-estate dealer, are excluded.
If you hold properties for investment (as opposed to holding as a dealer), you do NOT pay SE taxes, even if you are classified as a “professional.”
Generally, the only effect of being a RE professional is the removal of the passive loss limitation.
OK, Mark. I should not have made any reference to a dealer activity, since my earlier point only related to the real estate professional’s treatment of profit from the sale of real estate for which the passive losses had been converted from passive to active losses.
In light of your comments, I am still unclear on this point. The obtuse language in the Treasury Regulations only cloud the issue. If I may exerpt from Treasury Reg 1.469-2T(c)(2)(i)(A)(3).
“If the activity is not a passive activity of the taxpayer for the taxable year of the disposition, the gain is treated as not from a passive activity.”
IRC section 469 tells us that a rental property activity is not a passive activity for a real estate professional. In essence the real estate profesional is allowed to convert a formerly passive loss to an active loss. If the taxpayer is currently taking active losses for his rental property at the time that property is sold, then how would you apply Tres Reg 1.469-2T to the sale profit for a property from a “non-passive” activity?
At the core of this question is whether the real estate professional loses capital gains tax treatment because his profit is treated as derived “not from a passive activity.”
It seemed logical to conclude that if passive losses are converted to active losses, then profit from the disposition of the property would be active income.
Interesting. Well, probably not for the other readers!
I look at the property in the same light as a factory: Property owned for the production of income. Even if the income is active, the sale of the property itself is still capital. (isn’t it? I’m not sure anymore since this goes against the Reg you quoted.)
We can agree, though, that if the nature of the business is “selling property” (eg: a dealer) then the property becomes inventory and the sale becomes business income.
I see your point. I guess we should scope this out - both for our benefit as well as that of the board. We may be confusing “not from a passive activity” with “not capital.” I’ll see what else I can come up with.
But back to an earlier post of yours:
if the real estate professional's rental income is a net positive, then it is also subject to self-employment income taxes.
Rental income is specifically excluded from SE calculation by the real estate professional unless he is a dealer.
As always, Dave, thanks and take care.
Consensus of professional opinions among my peers is that it’s a capital gain.