The IRS Publication 925 outlines the requirements for individuals to qualify as a real estate professional for tax purposes.

To meet these requirements, investors must spend a certain amount of time each year working in real estate. The rules for qualifying as a real estate professional include the “More Than 50% Rule”, the 750 Hour Requirement, the Single Taxpayer Requirement, and the Material Participation rule.

1. More Than 50% Rule

This means that more than half of the services performed within the tax year must be in “real estate property trades or businesses.” In simpler terms, you must spend more than 50% of your working hours in real estate to qualify. However, if you have a full-time job outside of real estate, this rule may eliminate you from being classified as a real estate professional. For example, if you work 40 hours a week at a non-real estate job and only spend 5 to 10 hours per week managing a rental property, you would not meet the requirements to be classified as a real estate professional for tax purposes.

2. The 750 Hour Requirement

The second qualification for individuals to be considered as real estate professionals for tax purposes is to spend more than 750 hours a year providing services related to real estate trades or businesses. To provide some context, a typical full-time employee works between 1600 and 1900 hours per year. The 750-hour requirement is calculated annually, from January to December, and there are no restrictions on when these hours can be worked as long as they fall within the tax year. Activities that count towards this requirement include rental unit management, new construction, property and business operations, time spent as a real estate agent or broker, property development or redevelopment, and property acquisition. Real estate professionals are also advised to consider their property interests as one business activity rather than separate businesses. This means that property management and operations on each home count towards the 750-hour requirement, as opposed to each property having its own 750-hour requirement. It is important to note that real estate professionals must keep documentation of these hours and provide proof to the IRS.

3. The Single Taxpayer Requirement

This means that each person who wishes to qualify as a real estate professional for tax purposes must individually meet both the 50 percent rule and the 750-hour requirement annually. This means that hours cannot be combined with a business partner or any other individual to fulfill the requirements. However, there is an exception for married couples who file their taxes jointly. If one spouse meets the 50 percent rule and 750-hour requirement, the couple can combine their income for tax purposes, even if the other spouse earns their primary income outside of the real estate. This can be advantageous for couples where one spouse is a real estate professional and the other is not. It’s crucial to keep in mind that the IRS has strict guidelines for determining if someone qualifies as a real estate professional for tax purposes, and the requirements can be intricate. Therefore, it’s always recommended to consult with a tax professional to ensure that you meet all the necessary criteria and are taking full advantage of all available tax benefits.

4. The Material Participation Test

The IRS uses this to determine whether your working hours can qualify you as a real estate professional. This test is used to distinguish between active and passive owners. In order to meet the criteria for material participation, you must satisfy at least one of seven criteria. One of the most commonly used criteria is participating in the activity for at least 500 hours. This is often used in conjunction with the requirement that professionals work 750 hours in real estate. It is important to identify all businesses or real property trades that you materially participate in.

Real estate investing offers various perks, and tax benefits are among the most appealing ones. Therefore, it’s essential to understand how to utilize them to your advantage. For real estate professionals, losses and depreciation can be leveraged to their benefit. However, it’s crucial to maintain proper documentation to meet the IRS requirements mentioned earlier. It’s advisable to seek assistance from a qualified tax professional while navigating the qualifications and requirements. This way, you can take advantage of the many benefits of real estate investing and enjoy the returns it offers.