Real estate professional

Does the status of real estate professional cause a lot of ‘potential problems’? My colleague said that to me and walk away. I had no idea what you meant at all. I do not want to come across as being dumb to go to ask him what he actually meant to say.

Taxpayer has four rental properties, is the 750 hours of service a year requirement to become a real estate professional on each property or on the total service hours that he perform on all the properties together?

Thank you,

All properties together.

I've always considered being a real estate professional as preferable to being a real estate investor, but I am anxious to see if anyone has a contrary thought.

Did any of your clients experience 'potential problems' by filing as a real estate professional?

This client has 4 rental properties and he works as a property manager on the side too even though the majority of his time is spent on his own rental properties. So it is quite obvious that he fits the definition of being a real estate professional.

no

I have several RE pro's and never had an issue as long as you can support the tests. I even have one who is a full-time teacher and a full-time RE broker with rental properties. Audited three times for the RE losses allowed due to RE pro status. All three times they said "no way can he spend more than 50% of his working time on RE when he has a full-time job". All three times we had the calendars and docs to prove he did and all three times we won easily.

I think maybe the problem lies with documentation. If the client is willing to keep hours records, etc, and meets the other requirements then go for it. Oh if he does that, tell him to keep mileage logs too.

We all know how they want the benefits without putting in the work.

My two cents

Make sure your client knows what they need to substantiate that position, and that they're actually keeping those records, AND that they actually qualify. Hint: someone with a full-time W-2 is almost certainly not going to qualify...unless it's their own company involved in a RE trade or business.

Then consider a grouping election. Pros and cons.

It's not that hard. I imagine your partner was referring to taxpayers who claim RE pro but have nowhere near the hours or can't substantiate it. That could lead to very material adjustments and large P&I.

Taxpayer has four rental properties, is the 750 hours of service a year requirement to become a real estate professional on each property or on the total service hours that he perform on all the properties together?

Thank you,

There are several steps to go through.

First, the 750 hours. That is to be reached by only one person (taxpayer or spouse), can be any real estate trades or businesses that s/he materially participates in. This means activities such as flipping, brokerage, whole selling or construction count. For this material participation test, you can group activities, this does not require an election - only needs to be an "appropriate economic unit". Look up Reg. Section 1.469-5T and the 469-4 for the "slice and dice" election.

Once the 750 hours are reached, this needs to represent more than 50% of all the activities of the person.

For the two tests above, contemporaneous documentation is key. This is where problems can potentially arise.

If you have both, you qualify as a REP. What you earn is... the right to demonstrate that your rental real estate activities are not passive. You still need to pass the material participation test for the rental themselves. Here, you can use the hours of both spouses, and this where you need to meet the requirement for each property, unless you make a formal election to group your rentals together under 469-9. It's an all or nothing election, no cherry-picking.

Where it can get messy if of course if you don't understand all the steps and mess some steps up, but other than this, I mostly see advantages.

The two main drawbacks are - once you make the grouping election, if you sell one property, the passive losses that may have been generated prior to becoming a REP don't get unsuspended. You would need to divest the whole rental activity.

And - passive losses from prior to becoming a REP remain passive and that can be an issue to offset, if you don't generate any more passive income. So, there is some prior planning to do.

Tax Advisor has a lengthy article on this topic, where I would differ with the above answer is that "material participation" is the Tax Court has limited qualified activities to those of "landlord v. tenant" activities, investing activities do not qualify.
And, in the case of a married couple, they combined hours do not qualify (H 400 W450) does not qualify to reach the threshold of 750-hours. Search the Tax Court for either using "469" or "material participation" or "real estate professional",
read all the cases.

T.C. Memo. 2020-44 Docket No. 11642-18
This is a must read, where you have clients with rental properties.

Question:
If one has PAL C/Os from the PY when they weren't a RE professional, & this year they documented their hours to qualify as a RE professional, are they free to claim or not to claim the RE professional status, depending on whether their CY rentals are profitable, thus producing passive income able to offset PY PAL CF, or to use the RE professional status if their CY rentals are showing a loss, to make the loss deductible? Assuming they always have proper records, could they alternate years claiming the status or not, depending on the CY rentals bottom line, till they used up all PAL CF? Or is this not allowed?

What you're describing is a "former passive activity". Touched on in a few IRS pubs and the IRC 469 regs.

CY loss is nonpassive. Special treatment for the accumulated and carried forward PALs.

I know this. My question was - is the TP allowed to alternate RE prof (active) years v PA years? That is, if the TP has documented 750 hrs etc, are they allowed to not claim a RE prof status if it suits them better to NOT claim it?

My understanding is that RE pro is a question of fact. I.E. what transpired during the tax year in question. It is NOT an election.

I'd like to be proven wrong here... Might be useful for planning purposes.

But if in some years their records (750 hrs etc) aren't well kept, then even if in fact they meet the requirement, you wouldn't claim the RE prof status without good records, right?

So, could a TP just not volunteer their hours records to their tax preparer, unless the tax preparer saw that being a RE prof is beneficial to the client, and asked them for these records?

I won't expose myself to preparer penalties. At the same time, if I'm not exposed to penalties, we're not detectives or auditors. If you ask a plain language question and the client understands that question and responds...all of this in writing, I think we can rely on that.