Qualifying as a Real Estate Professional

Either you or your spouse will qualify as a real estate professional for the year if you or your spouse spends

1. more than half your personal service work time in real property trades or businesses in which you materially participate, and
2. more than 750 hours of your personal service work time and investment analysis time in real property trades or businesses in which you materially participate.

Example. You work 925 personal service hours a year on your rental properties and 921 hours (excluding vacations, holiday, and sick days) on your W-2 job as the owner-employee of your S corporation. You pass the 750-hour test and you pass the more-than-half-your-work-time test (1,846 total personal service hours divided by 2 equals 923 hours—you worked 925 hours on the real estate). Thus, you are a real estate professional for the year, and you may deduct your rental property losses on the properties in which you materially participate.

Planning note. Investor time counts for the 750-hour test but not for the more-than-half-your-personal-services work-time test.

One spouse must single-handedly satisfy the time-spent rules for real estate professional classification. When one spouse passes the time tests, both spouses are deemed to pass. Thus, if the wife qualifies by herself as a real estate professional, tax law deems the husband a qualified real estate professional, too.

Proof of Time Spent

You need proof of time spent. In its audit guide on rental properties, the IRS lists the following two techniques for IRS examiners to follow:

1. Request and closely examine the taxpayer’s documentation regarding time. The taxpayer is required under Reg. Section 1.469-5T(f)(4) to provide proof of services performed and the hours attributable to those services.
2. Scrutinize other activities the taxpayer is engaged in, to determine whether time claimed makes sense.

The IRS tells its examiners that your “reasonable records” of time spent may include:

• identification of the services provided; and
• the approximate number of hours spent, based on appointment books, calendars, or narrative summaries.

Keep in mind that the burden of proof is on you, the taxpayer. Thus you need proof of time spent. For more on how to keep your proof and why this is critical to your passive loss deductions, see FAQ titled “How to Audit-Proof Your Time Spent on Rental Properties.”

Real Property Trades or Businesses

Time spent on your rental property is time spent on your real property trade or business. Remember, either you or your spouse must pass the time test for real property trades or businesses in order to qualify for tax-favored real estate professional status.

The term “real property trade or business” means any real property

Employee alert. Personal services performed as an employee do not count as work performed in real property trades or businesses unless such employee is a 5-percent-or-more owner.7 You are a 5-percent-or-more owner if you own (or are considered to own) more than 5 percent of your employer’s outstanding stock, outstanding voting stock, or capital or profits interest.

Real estate agent. Brokerage includes activities by a real estate agent—see FAQ titled “Are Real Estate Agents and Real Estate Brokers One in the Same for Passive Loss Rules?”