Real Estate Professional Tax Benefits & How To Qualify

Qualifying as a real estate professional means that you are allowed to deduct your passive losses from your ordinary income and that there are no limitations to the amount of loss you can deduct in any one year. Most real estate investors, however, do not qualify for this beneficial tax status as it requires you to meet two key criteria.

To qualify as a real estate professional, you must:

• Spend more than 50% of your working time working in a real estate business.
• Work at least 750 hours in a real estate trade or business.
• Be materially participant

In this article, we take a look at the tax benefits that come with qualifying as a real estate professional and how qualify for REPS.

What is a Real Estate Professional?

According to the IRS, there are three classifications of real estate investors.

1. Passive Investor

The category with the least amount of benefit to the taxpayer. Only the ability to deduct passive losses against passive gains is offered.

2. Active Investor

This classification allows the taxpayer to deduct up to $25,000 of passive losses against the typical income. However, this deduction is not available upon meeting the Adjusted Gross Income (AGI). For a married couple who have filed jointly, this is $150,000, and for an individual the AGI is $100,000.

3. Real Estate Professional

A real estate professional is eligible for 100% of all passive losses against their typical income. However, being deemed a real estate professional does not immediately grant the ability to offset all losses.

Passive losses can only be offset by passive income. The main perk of deducting passive expenses is that it will decrease your tax liability.

There are a set of criteria, outlined by the IRS, that is needed to approve this benefit. Proving material participation is one of the criteria needed to achieve this perk.

Real Estate Professional Tax Benefits

The IRS recognizes Real Estate Professional Tax Status as a special designation that can offer substantial tax benefits to individuals involved in real property trades or businesses.

For qualifying investors, this status allows rental activities to be treated as active income rather than passive income, meaning rental losses can be fully deducted against other income. As a result, investors may significantly reduce their overall tax liability by offsetting rental losses against wages, business income, or other earnings.

1. Full Deduction of Rental Losses

Normally, rental income is considered passive, and passive losses can only offset passive income. But if you qualify as a real estate professional, rental activity is considered active.

This means you can deduct rental losses against your active income (like business income or capital gains). 

Note: if you hold a W2 job, the IRS will closely scrutinise your REPS claim as it is unlikely you will be able to meet the 750-hour test.

2. Reduces Overall Taxable Income

Since you can deduct those losses from your active income, your total taxable income may drop significantly, potentially putting you in a lower tax bracket or reducing your total tax owed.

3. Bonus Depreciation and Cost Segregation Become More Valuable

As a real estate professional, you can make better use of accelerated depreciation strategies, like bonus depreciation or cost segregation studies.
These allow you to front-load depreciation expenses, increasing losses that you can deduct from active income.

4. Avoid the $25,000 Passive Loss Limitation

Non-qualifying individuals may deduct only up to $25,000 in passive rental losses per year (and only if their income is under $100,000). REPS removes that cap entirely, unlocking much larger deductions.

5. Not Subject to Passive Activity Loss Limitations

Because your rental income is no longer passive, the Passive Activity Loss (PAL) rules don’t apply. This simplifies tax planning and opens up more flexibility.

How To Qualify As A Real Estate Professional 

More than 50%

Over 50% of the hours worked must be in real estate businesses. For example, a person who works 500 hours a year in a non-real estate industry will need to perform at least another 500 hours within the real estate business to qualify.

The next part of this rule stipulates that 50% or more of the real-estate-related services must have material participation. The term, ‘materially participate’, as defined by the IRS, is the method of determining one’s active or passive participation in a business venture. The main test of being materially participant is working more than 500 hours in a real estate business over the course of the year.

Investor hours do not count towards the 50% rule. This includes activities such as financial statement reviews, investor report preparation, researching new property, and general finance reviews.

Material Participation

Tests for material participation include:

• The individual’s participation represents all of the participation for that tax year – including people who are not owners of an interest in the property.
• The total hours of participation of the individual exceed 500 hours.
• The individuals have materially participated in the business for any five tax years (consecutive or not) during the last 10 tax years that precede the current one.
• The property is a personal service activity and the individual materially participated in the said activity for three tax years (consecutive or not)
• Based on facts and circumstances, the individual materially participates in the property on a regular, continuous, and substantial basis during the tax year.

Requirement of 750-Hours

When aiming for a 750-hour requirement, the previous 500 hours of material participation assists this greatly. Much like the previous rule, all hours that go towards tax deductions must be in the real estate business.

Real estate investors will need to prove that they have completed over 750 hours working in real estate and are required to support their claims with documentation.

Tracking Your Real Estate Activities With Landlord Studio

You can use software like Landlord Studio to keep track of the total number of hours worked in a real estate business.

While Landlord Studio doesn’t have an hour tracker (currently in development), you can use the mileage tracker. This allows you to record the date of the activity, the time spent, the location and purpose of the work, and any additional notes. At the end of the year, you can then simply generate a report to calculate the total number of hours worked as a real estate professional. Additionally, you can upload any supporting documentation and store it securely and organized in the system for reference at a later date.

Electing a Single Activity

In the event the owner has more than one rental, they can aggregate and elect all real estate businesses as a single activity. This makes it easier to gather and track the total hours spent in a qualifying activity.

If the properties are not elected as a single activity, then the 750-hour requirement will need to be met for each business. Qualifying one rental does not guarantee that the other properties are a single activity.

Although this makes it simpler and easier to build up the required number of hours, problems can arise if one of the properties that form part of the elected single activity is sold. As such, it is recommended that you consult with a qualified CPA or financial planner when deciding whether or not to elect all properties as a single activity.

Benefits of Qualifying as a Real Estate Professional: Example

Qualifying as a real estate professional means there are no limits set on the amount that can be deducted in a single year. Additionally, losses from your real estate business can be deducted against other income sources. As such, qualifying as a real estate professional can heavily reduce your tax liability.

To wrap it up in a relevant example, let’s look at James.

James is a real estate agent who earns above the passive activity limit of $150,000. Alongside his day job, James also has a rental property that harvests a $10,000 loss. Normally, he wouldn't be able utilize this as a deduction as he earns over $150,000 a year.

However, as he has spent 1300 hours representing his clients in both purchase and sale transactions. For tax purposes, James can elect all his real estate activity a single activity and count these hours towards qualifying as a real estate professional.

It’s not enough that James has the hours however. He must now also prove that he materially participates in the management of his rental.

Luckily for James, he kept contemporaneous records of his hours of active participation in the property to use when he substantiates his real estate professional category claim.

Final Words: Tax Benefits of Real Estate Professional Status

Whilst qualifying as a real estate professional does come with tax benefits, doing so isn’t always easy. In order to maximize your tax deductions, you need to employ good systems and software to keep accurate and detailed records not only of each and every deductible expense but of the hours spent in material participation of your properties.

Finally, it’s always worth discussing this with a licensed CPA or accountant in order to ensure you are keeping all the required records and remain compliant with the relevant laws and regulations.

* First 3 properties free.