Real Estate Professional - 750 hour question

[Joe Spinelli]

Hello everyone!  I know the criteria to be a RE Professional is 750 hours in RE and more hours in RE than any other job.  

My accountant told me that I need to spend 750 hours PER PROPERTY which does not make sense.  He also told me that I need to be active on every property or I can only claim active income on those properties for which I was active.  That part does make sense.  

For example: if I managed 123 Main St. but had a property manager manage 123 Spruce St, I can only claim active income on 123 Main St.  123 Spruce St. would be passive income.  

Any insight would be helpful.  Thank you.

Joe

[Ashish Acharya]

Originally posted by @Joe Spinelli:

Hello everyone!  I know the criteria to be a RE Professional is 750 hours in RE and more hours in RE than any other job.  

My accountant told me that I need to spend 750 hours PER PROPERTY which does not make sense.  He also told me that I need to be active on every property or I can only claim active income on those properties for which I was active.  That part does make sense.  

For example: if I managed 123 Main St. but had a property manager manage 123 Spruce St, I can only claim active income on 123 Main St.  123 Spruce St. would be passive income.  

Any insight would be helpful.  Thank you.

Joe

Not correct. There are groupings available to meet the 750 hours and meet other requirements. 

1) first grouping can be done to see if your various ventures can qualify as a one economic unit. This helps when you don’t meet hours. 

2) second grouping can be done to meet the RE professional hours. 

3) third grouping can be done to check if you materially participate in your rentals. Special election required. 

Remember, once you meet the 750 hours, then you have to materially participate (not actively) in each rental or grouped rental as mentioned above to be able to deduct the losses. 

Just having a status without materially participating in your rentals does no good. There are seven ways you can materially participate. 

if you don’t understand what’s below, ask your tax advisor. 

A taxpayer materially participates in an activity if the taxpayer is involved in its operations on a regular, continuous, and substantial basis.

Other there is a quantitative test:

• 1. More Than 500 Hours Test. The taxpayer participates in the activity for more than 500 hours during the year. NOTE: this is not annualized.
• 2. Substantially All Participation Test. The taxpayer's participation in the activity constitutes substantially all of the participation by all individuals (including nonowners) in the activity for the year.
• 3. More Than 100 Hours Test. The taxpayer's participation is more than 100 hours during the year, and no other individual (including nonowners) participates more hours than the taxpayer. 
  
• 4. Significant Participation Activity (SPA) Test. The activity is a significant participation activity in which the taxpayer participates for more than 100 hours during the year and the taxpayer's annual participation in all significant participation activities is more than 500 hours. [A significant participation activity is generally a trade or business activity (other than a rental activity) that the taxpayer participates in for more than 100 hours during the year but does not materially participate (under any of the material participation tests other than this test). Eg: Charles owns interests in a restaurant, a shoe store and an orange grove. Each of these ventures has several full time employees. As of Oct. 31, Charles has worked 200 hours in the restaurant, 200 hours in the shoe store, and 75 hours in the orange grove. If by the end of the year he puts in another 26 hours in the orange grove, he will have participated more than 500 hours in all his significant participation activities and the material participation standard will be satisfied.

Although the loss from the activity that does not meet SPA rule is passive, the gain might be caterized a non passive. If the taxpayer works fewer than 500 hours in all significant participation activities combined, overall losses from the significant participation activities are passive, but if there is net gain, a portion of the gross income will be recharacterized as nonpassive. In such cases, the net income of each activity with positive net income for the year is multiplied by a fraction: the numerator is the combined net income for all significant participation activities, and the denominator is the combined net income for the activities with positive net income.

Eg: Betty is a full-time teacher, but she also owns stock in two S corporations (Acorp and Beecorp) that pass through income to her. Betty significantly participates in both, performing more than 100 hours annually in each, but she does not participate in either (or both combined) for more than 500 hours. Other shareholders participate to a greater extent than Betty. During the current year, she participated 150 hours in Acorp and 300 hours in Beecorp. Betty is also a partner in a limited partnership that passes through losses, but she does not participate at all in that activity. Can the limited partnership losses be offset against S corporation income?

Betty significantly participates in each S corporation. Therefore, the income is recharacterized as nonpassive and cannot be offset against the partnership's passive losses.

• 5. Prior-year Material Participation Test. The taxpayer materially participated in the activity for any five tax years (whether or not consecutive) during the 10 immediately preceding tax years.
• 6. Personal Service Activity Test. For a personal service activity, the taxpayer materially participated for any three tax years (whether or not consecutive) preceding the current tax year. (Personal service includes the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital is not a material income-producing factor.)
• 7. Facts and Circumstance Test. Based on all the facts and circumstances, the taxpayer participates on a regular, continuous, and substantial basis during the year. Future regulations are to provide further guidance for this test. However, temporary regulations indicate that if an individual participates in an activity for 100 hours or less during the year, this “facts and circumstances” test is not available. Participating in the management of an activity is not considered for this test if (a) any person (other than the taxpayer) received compensation for performing services in the management of the activity, or (b) any individual spent more hours during the tax year performing management services than the taxpayer (whether or not the individual was compensated for the management services).