My Real Estate Professional System

We’ve wrapped up our 2016 tax filing, and once again I certified that I am a “Real Estate Professional” and it saved us a boat load of taxes. If you’re looking to how you might reduce your tax bill, make sure you figure out if you qualify as a real estate professional.

How you qualify

I will defer on the specific recipe for how you qualify to be a Real Estate Profession to the CPAs. Brandon Hall and Amanda Han have both written great articles on the how you qualify. You do not need your real estate license, it’s just a matter of spending the right amount of time on the right kinds of activities.

How to avoid getting audited

As for not getting audited, there is no recipe, that's just (bad) luck. I have heard that being a real estate professional increases your probability of audit significantly so make sure you qualify before claiming this status on your tax returns. If your records and actions would stand up to an audit then you've got your bases covered.

Keep good records

Since your chance of audit is higher, keep good records. If you’re legitimately doing the work, and recording it, an audit should be an inconvenience, but really just an exercise in digging up the proper documentation. So let’s talk about what that documentation looks like. Mine consists of two things: a spreadsheet log and a directory of scanned items.

Real Estate Professional Log

I keep a spreadsheet that totals the time I’ve spent as a real estate professional. You could keep a journal, calendar, or anything that you will consistently use. Here’s a snippet of what mine looks like. I also use it to track mileage driven. If you drive a lot of miles for your real estate related activities, you’ll probably want to track them on a more sophisticated tracking system.

Keep a “Prove it” directory

Whenever there is something I can scan or save to "prove" I did what I said I did on my real estate professional log, I do that. My prove it directory is a collection of pdfs, jpgs, word docs and spreadsheets. Each file is named YYYY-MM-DD-ShortDescription.

When I attend an REI meetup, I make sure to take a few notes and scan those, or scan any agenda I was given and dump it in my prove it directory. If I make a phone call, I scan my chicken scratch notes from the call which corroborates the 30 minutes I spent on the phone with the mortgage company working out why they failed to pay the insurance from escrows. If whatever I was doing generates emails or files elsewhere, I don't worry about putting anything in my proof directory.

A few example files might be:

2017-05-24-CallMortgageCompany.pdf

2017-05-24-CallWithPropertyManager.pdf

2017-05-25-SendFundsForRepairingAirConditioner.pdf

Why bother with the real estate professional status?

This is something that I should again defer to the CPAs. In my case I have less cash flow from my properties than I can shelter with depreciation, and my husband has high W-2 income. That means we have passive losses.  Claiming the real estate professional status on our tax returns saves us BIG time on our taxes because we can use the passive losses to shelter active income. Your mileage may vary, and this is something to talk about with your CPA.

The Gotcha

Keep in mind that the real estate professional status allows you to take advantage of depreciation NOW which means you have a bigger depreciation recapture LATER in the event of a sale. Make sure you either figure this into your calculation, or find ways to continue to defer the taxes. You can defer paying the taxes with a 1031 exchange, which as of 2017 remains a viable alternative. You can also never pay the depreciation recapture by dying while owning the property. While this is not my favorite scenario since it involves the end of my life, the concept of dying while owning properties has to be one of the most magical tax reduction options out there.

Anyone else out there a real estate professional? What kind of system do you use to track your Real Estate Professional Status?