In a prior article we discussed the various tax advantages of real estate investing. In today’s quick snippet we will dive into one of those in more detail – real estate professional status (aka REP or REPS). As always, before taking any steps, please consult with your CPA.
In prior snippets we discussed the concept of depreciation, how it results in paper/tax losses, which one can deduct against taxable income (typically against other passive income).
You can generally deduct up to $25,000 in passive losses against your ordinary income (W2 wages) if your modified adjusted gross income (MAGI) is $100,000 or less. This deduction phases out by $1 for every $2 of MAGI above $100,000, until $150,000 when it is completely phased out. This is where REPS can be beneficial.
REPS effectively enables a qualified individual to apply real estate losses against one’s income.
To achieve a REP status, one must spend: (i) more than 750 hours per year on a real estate business, (ii) more than 50% of the time on a real estate business AND more than anyone else. The 50% rule makes it difficult for a full time W2 earner to qualify as a REP as it is generally very difficult to prove that you work more than 40 hours a week on the real estate business in addition to your full time job. You must track your hours and be able to clearly document activity, in the event of an audit.
For more details on REPS and REPS qualifications, you can check out the IRS guidance IRS Publication 925 on passive activity rules.
To be able to apply real estate losses against one’s taxable income one should be able to prove not only a REP status but also material participation in the trade or business.
The benefit of being able to qualify as REPS and material participation is overall reduction in your tax bracket to as low as 15% (vs. 35%). Whether you are single individual or filing jointly, this can be meaningful.
For a couple with high combined W2 wages or other high income earners in general, the tax deferral or tax savings can be impactful. For example, if you make say $250K/yr and your spouse manages the real estate investment portfolio full time and generates $100K in passive losses due to cost segregation, depreciation, or other tax deferral strategies, your household income reduces from $250K to $150K, putting your family in a lower tax bracket.
Which one of you becomes a REP will depend on your individual income levels, career trajectory and job satisfaction, and passion about real estate. Perhaps your roles are already somewhat defined or perhaps one of you already works part-time and therefore being able to dedicate the additional time required to manage the real estate business. Whatever your circumstances, the spouse who will manage the real estate portfolio will in effect run a business.
We hope today’s quick snippet provided food for thought and that it at least suggested questions and discussion topics you can bring up next time you meet with your CPA to determine if and how they could apply to your individual situation.
Vessi Kapoulian
Peeling back the layers of passive real estate investing, so you protect the downside and invest with clarity and confidence.
Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.
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P.P.S. The second edition of The Busy Professional’s Guide to Passive Apartment Investing is now on Amazon in paperback, audio, and digital. I expanded the diligence chapters and updated the material that had aged since the first edition. It is written for investors who want to vet a passive deal with confidence and clarity.