IRS Passive Loss Labyrinth: RE Pros, Part II

How to navigate the IRS Passive Loss Labyrinth, continued from Part I

Real Estate Professionals and Material Participation. Second of IV parts.

By Gary Krupa, CPA.
May 22, 2021.

Updated on:
May 23, 2021.
June 5, 2021.

Passive loss Rules Labyrinth

The IRS Passive Loss Labyrinth

What you’ll need to do to qualify as a Real Estate Professional

First you’ll need to perform services in a real property trade or business. You can work in, for example, real property development, rental, and management. The list includes real estate brokerage, but not mortgage brokerage.

You’ll then need to pass two quantitative tests for those activities. They are:
a. Spend more than half of your time on them compared to the time you spend on all trade or business activities.
b. Spend more than 750 hours of your time on them.

Next, to determine whether or not you qualify:

Step 1. Identify, then group your real property trades or businesses.

Step 2. identify your real property trades or businesses in which you material participate.

Step 3. total your hours participating in those activities. If you’re married, count only the hours for the spouse seeking to qualify as a real estate professional. This means you can’t include your spouse’s hours if you seek to qualify.

Step 4, apply the two quantitative tests as stated above in a and b to the total number of hours. Don’t leave non-real estate hours out of your calculation of a. Include a reasonable number of hours for them.

If you pass both of the tests in a. and b. above, congratulations. You’re a qualified Real Estate Professional.

Now you need to establish Material Participation

You haven’t found your way out the labyrinth yet, however. You must still materially participate in your real estate activities. See Part III for a list of ways to do this according to the IRS regulations.

Determine if you materially participate in each real estate activity. However, before you can do that you’d need to qualify as a Real Estate Professional.

Once you materially participate in an activity, you may report it as active. Otherwise it’s passive.

You may instead combine or “aggregate” your hours spent on all your rental real estate activities.*You can then determine your material participation on that basis. If you materially participate in the combined activities, they’ll all be non-passive. Otherwise they’ll remain passive.

To increase the odds in your favor, you may treat different types of real estate activities as one business. E.g. you can combine your hours spent on a construction activity with those of your rental activity.

Next, in Part III: Material participation according to the IRS regulations

For more information on Suspended Passive Losses

This article applies the passive loss rules to the sale of your rental property: What Happens to Suspended Passive Losses When You Sell (Or Lose) Your Rental Property?

*This is per IRS Regulation Sec. 1.469-9(g).

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