Follow Chad Linkedin
Email Chad Email
Financial
Jun 15, 2017

Real Estate Professional Election And The IRS

Sponsored Content provided by Chad Wouters - Partner, Earney & Company, LLP

There are many reasons people tend to own rental properties - investment purposes, cash flow purposes or even as part of a tax planning strategy.
 
Depreciation and other deductions associated with rental properties often provide taxpayers with valuable tax benefits, including generating paper losses associated with those activities. The rules regarding whether those losses can be deducted can get very complicated and difficult to navigate.
 
The IRS has a variety of rules related to whether taxpayers can deduct losses associated with rental real estate, but most of those limitations can be overcome if the taxpayer is able to prove he or she is a “real estate professional” in the eyes of the IRS.
 
The IRS has a list of criteria to help taxpayers determine if they are a “real estate professional” but the two most important are:

  • More than half of the total personal services the taxpayer performs in trades or businesses is performed in real property trades or businesses in which the tax materially participates
  • The taxpayer performs more than 750 hours of services during the tax year in real property trades or businesses.
If a taxpayer can prove these two criteria, then most likely, he or she will be able to deduct rental losses in full. However, the situation gets murkier when multiple rental properties are owned. Technically, if a taxpayer owns multiple rental properties he or she would have to meet criteria for each property, which if you look at that criteria, would be impossible to do.
 
Let us look at an example: John Smith has investment income and other ordinary income of $175,000, and he also owns two rental properties that each generate a $5,000 tax loss. If John spent 1,000 hours on producing his other ordinary income (say he is a marketing consultant and produced the income from consulting activities), 800 hours on Property A and 400 on Property B, then under current IRS rules John would not be able to deduct any of the losses. However, they would get carried forward and potentially deducted in a future year. This could cost John several thousand dollars a year that could be used for future investments, upgrades to the property or even his daughter’s college tuition.
 
The IRS does have a way around this limitation, and it comes by way of special election that has to be made on the tax return to group all rental real estate activities and treat it as one activity. Often, many taxpayers do not take advantage of these elections or don’t update them properly as they acquire new properties. This mistake can prove costly to the taxpayer.
 
Looking back at our previous example, if John had made the election to group his two properties into one, he would have been able to deduct his losses in full. Since he worked 800 hours on Property A and 400 hours on Property for a total of 1,200 hours - and because he worked 200 hours more on rental real estate activities than his consulting activities - he meets both criteria. This can only be accomplished by making the proper elections with the IRS when filing your tax return.
 
Rental real estate carries with it a lot of rules and regulations from the IRS, so it is of the utmost importance to make sure you are handling these correctly. The real estate professional election does have some drawbacks, including limitations when selling properties at a loss, which is even more reason to make sure you are having the discussion with your tax preparer and doing what is in your best interest for your specific situation.

Chad Wouters, CPA joined Earney & Company in December 2006 and became the tax partner in November 2013. With an emphasis on strategy and planning, Chad works with his clients all year to ensure the most efficient tax strategies are put into place.  Earney & Company, L.L.P.  is a CPA firm that handles tax compliance, consulting and planning as well as audit and other assurance services.  For more information please visit www.earneynet.com or call (910) 256-9995.  Chad can also be reached at [email protected].


 
 

Ecolarge
Ico insights

INSIGHTS

SPONSORS' CONTENT
Hardyheadshot

Start Your Doctor of Nursing Practice Degree to Get Ahead of the Curve

Charles Hardy - UNCW College of Health and Human Services
Infinity 891835159

What is EMV and Am I Liable?

Kyle Thorpe - Infinity Payment Systems
Fredheadshot 5119113348

Homeschooling is on the Rise; Organization is, Too!

Fred Kumpel - Strickland's Home

Trending News

Entrepreneur Richard Johnson's Latest Project Aims To Boost Burgaw

Johanna Cano - Jun 14, 2019

New Hanover Regional Grows To A $1.2B Operation

Vicky Janowski - Jun 14, 2019

Plastics Molding Manufacturer Gets Its Start In Wilmington

Christina Haley O'Neal - Jun 14, 2019

Field Of Vision

Jenny Callison - Jun 14, 2019

In The Current Issue

Novant Health Orthopedics & Spine Opens In Supply

Novant Health has opened an orthopedics and spine office in Supply, providing degenerative spine condition services, orthopedic spine surger...


WilmingtonBiz Magazine's Health Issue Is Out

The Greater Wilmington Business Journal's latest edition of the WilmingtonBiz Magazine is out. The issue takes an in-depth look at the area'...


MADE: Production Capacity

From power cords to nuclear fuel, manufacturing companies across the Cape Fear region are making a wide range of products. Here’s a recap of...

Book On Business

The 2019 WilmingtonBiz: Book on Business is an annual publication showcasing the Wilmington region as a center of business.

Order Your Copy Today!


Galleries

Videos

2019 WilmingtonBiz Expo Keynote Lunch - CEO, nCino, Pierre Naude`
Transporting the Future - Power Breakfast 3.12.2019
Health Care Heroes 2018