Real Estate Professional or Not?

Question

Hello,

My wife and I finished building our first rental this year and it is in service:)  I am talking with a new cpa about the upcoming tax season and when I brought up the idea of claiming my wife as a real estate professional, he really didn't like the idea.  I am not sure why as my wife was the general contractor, she has a GC license from the city and we well exceed the 750 hour requirement?  Our AGI will be high enough that it will severely limit us taking any losses.

If anyone has any other insights/comments please let me know.

Thanks in advance,

Ed C.

Bill Walston · Answer

Dang it @Brandon Hall!  Apparently I was still in a "turkey coma" when I responded to that post.  As you can see, I completely read it as DEALER and not PROFESSIONAL and answered accordingly.  You are correct and, obviously, my inference WAS way off base.  Now, IF the OP had been talking about "dealer status" I would stand by my answer ;)

Brandon Hall · Answer

@Bill Walston Achieving the "real estate professional" status has nothing to do with whether your properties will be classified as inventory or investment property. This is simply a way to judge participation in your real estate activities, it is not a means to determine what that business actually does (i.e. flip vs. buy-and-hold).

Additionally, rent from your real estate is specifically excluded from the definition of self-employment tax.

Per the AICPA: "A taxpayer may be able to avoid certain taxes by being classified as a real estate professional. Income arising from "rentals from real estate" is excluded from the definition of self-employment income for the purpose of the self-employment tax. Additionally, the Sec. 1411 tax on net investment income does not apply under a safe-harbor provision for real estate professionals who meet certain criteria."

Brandon Hall · Answer

Account Closed

Can you provide more details about your wife? For instance, does she have a full-time or part-time job? Did she document the hours it took to complete the project? As a GC she can count all of the hours she spent managing the project, including personnel.

As I am sure you know, if she can be classified as a real estate professional, all real estate losses can be used to off-set your combined ordinary income assuming you file jointly. To qualify, 51% of the personal services she performed in all trades or businesses during the tax year must be performed in real property trades or businesses in which she materially participated AND she performed more than 750 hours of services during the tax year in real property trades or business in which she materially participated.

However, if she is working in the real estate field (i.e. as a GC) but working for someone else (i.e. an employee), she cannot count these hours or services toward the two criteria stated above unless she owns at least 5% equity in the business she works for.

If you can elaborate on your wife's business activities I will be able to provide a clearer picture.

Account Closed · Answer

Thanks for the responses...  My wife up until last year is primarily a stay at home wife.  The idea, is over time that this will turn into a full time career for her as our kids are getting older...  We do have all the documentation of hours worked, miles traveled, etc...  We own 100% of the rental property we built.

I talked to the cpa again and he is still not on board as he said it would generate self employment income for my wife and up front we would get a short term gain, however in the long run we would lose out.

I am going to visit with a few other cpa's as I don't think he is understanding the situation.

Thanks,

Ed C.

Bill Walston · Answer

ummm - Did you bother asking the CPA WHY he didn't like the idea?  Most CPA's are pretty much on board with any tax strategy that will reduce a clients taxable income UNLESS there is a compelling reason not to.  For instance, you say that you have constructed your first "rental" and it is in service.  That statement alone would have me suggest that you NOT want to be a dealer.  Why in the world would you want your rental income to be classified as ordinary income and be subject to self-employment tax?  Why would you want the property itself to be classified as "inventory" rather than "investment property." That's what would happen if you were classified a dealer.  Notwithstanding the fact that you wouldn't be entitled to depreciation during your holding period, nor capital gains treatment if you ever decide to sell your rental.  Unless my inference from you statement is WAY off base (and I don't think that it is) I agree with your CPA.

Real Estate Professional or Not?

Most Popular Reply