Resources
Real Estate Professional Status
Generally, rental activities are passive activities even if you materially participate in them. However, if you qualify as a real estate professional, rental real estate activities in which you materially participate aren’t passive activities. This means you can recognize rental losses against other income sources.
To qualify as a real estate professional, a taxpayer must meet the following two criteria:
1. More than one-half of the personal services performed (i.e. time spent working) in all trades or businesses by the taxpayer during the tax year are performed in real property trades or businesses in which the taxpayer materially participates, and
2. The taxpayer performs more than 750 hours of services during the tax year in real property trades or businesses in which the taxpayer participates.
Note: If you have a full time job in a non-real property trade or business, you will have a very difficult time defending the position that you spent more than one-half of your personal services in real property trade or businesses. A full time job is typically 2000 hours per year. In those cases in which you have a non-real estate W-2 job, you must be able to support (via time logs) that you spent 2001 hours in real property trades or businesses.
Real Property Trade or Business
The term “real property trade or business” means any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.
Material Participation
You materially participated in a trade or business activity for a tax year if you satisfy any of the following 7 tests; those most used in real estate are in bold:
1. You participated in the activity for more than 500 hours.
2. Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who didn’t own any interest in the activity.
3. You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who didn’t own any interest in the activity) for the year.
4. The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you didn’t materially participate under any of the material participation tests, other than this test.
5. You materially participated in the activity (other than by meeting this fifth test) for any 5 (whether or not consecutive) of the 10 immediately preceding tax years.
6. The activity is a personal service activity in which you materially participated for any 3 (whether or not consecutive) preceding tax years. An activity is a personal service activity if it involves the performance of personal services in the fields of health (including veterinary services), law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital isn’t a material income-producing factor.
7. Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the year.
You didn’t materially participate in the activity under test (7) if you participated in the activity for 100 hours or less during the year. Your participation in managing the activity doesn’t count in determining whether you materially participated under this test if:
– Any person other than you received compensation for managing the activity, or
– Any individual spent more hours during the tax year managing the activity than you did (regardless of whether the individual was compensated for the management services).
Cost Segregation Studies
A Cost Segregation Study is a tool in the real estate investor’s kit for assigning value to the subcomponents of real estate assets in order to benefit from accelerated depreciation on items whose useful life is less than the building’s default 27.5 or 39 year life. Accelerated depreciation expenses can result in paper losses that may decrease your overall tax liability in the year the study is applied. This may be the year the rental is first placed into service, if the return for that year has not yet been filed, or in a future year, when the cost segregation study is performed (which could be years after the rental was first placed into service), resulting in an adjustment to the current year return. There are rules about whether the losses can be utilized in the tax year claimed, so make sure you speak with a tax advisor about how a Cost Segregation Study may benefit you specifically before applying results to your scenario.
Beneficial Owner Information Reporting
The Corporate Transparency Act (CTA), enacted in 2021, was passed to enhance transparency in entity structures and ownership to combat money laundering, tax fraud, and other illicit activities. For entities that were formed prior to 2024, beneficial owners have until Jan 1, 2025 to make their initial report to the Financial Crimes Enforcement Network (FinCEN). Entities formed in 2024 will have 90 days after receiving notice of their creation or registration to file their initial report.
Who needs to file: Beneficial Owners of Reporting Companies.
Reporting companies are identified as either domestic or foreign
- Domestic reporting companies are corporations, LLCs, or any other entity created by the filing of a document with a secretary of state or any similar office under the law of a state or Indian tribe.
- Foreign reporting companies are a corporation, LLCs, or other entity formed under the law of a foreign country that is registered to do business in any state or tribal jurisdiction by the filing of a document with a secretary of state or any similar office.
- Sole-proprietorships that don’t use a single-member LLC are not considered a reporting company.
Beneficial Owners
A beneficial owner can fall into one of two categories, defined as any individual who, directly or indirectly, either:
- Exercises substantial control over a reporting company, or
- Owns or controls at least 25% of the ownership interests of a reporting company.
Reporting Company representatives and Beneficial Owners can use 3rd party providers to assist them in filing, or complete the filing for free on the FinCEN website. If you want assistance in filing, we recommend FileForms. If you would like to file on your own, we recommend creating a FinCEN ID for your Beneficial Owners, as well as filing the report using their website. By creating a FinCEN ID, the Reporting Company will not have to update its report every time a Beneficial Owner’s personal information changes.
Real Estate Tax Education
There is a lot of information in blogs, articles, social media and elsewhere that provides guidance about the tax treatment of certain real estate activities. There is a lot of BAD information out there (most non-tax professional social media posts and most TikTok videos). Two sources we like and trust are the National Association of Real Estate Tax Specialists and Hall CPA PLLC.
The National Association of Real Estate Tax Specialists (NARETS) has its own site with resources, which can be found here.
Hall CPA PLLC, also known as “The Real Estate CPA” has tons of free and paid educational content. One of our (free!) favorites is the Tax Smart Real Estate Investors Podcast, which provides excellent information about real estate related tax matters with court case examples and tax code citations.
Recommended Reading for Business Owners and Entrepreneurs
When I first started my own business, I read several books that deeply influenced the framework under which I now operate. The following are books I’ve read that I highly recommend.
Start with Why – Simon Sinek
Rich Dad Poor Dad – Robert Kiyosaki
Tax Free Wealth – Tom Wheelwright
Financial Freedom – Grant Sabatier
Financial Advisor – Edward Jones
Some of our clients are so successful that they need alternative or advanced options for qualified retirement accounts. The most common thing we see are taxpayers who contribute to a Roth IRA, only to find they exceed the income limitations to be eligible for contributing. One of the ways of bypassing this rule is to make non-deductible traditional IRA contributions, which can then be transferred to a Roth IRA (commonly known as via the “backdoor.”)
If you’re interested in backdoor Roth contributions specifically, or Financial Advising in general, we highly recommend Maureen Kane, AAMS®, CRPC®.
