Real Estate Income Tax Planning

Real Estate Income Tax Planning

Understanding Real Estate Investor Classifications-

Real estate investing can be a good strategy for building wealth and reducing your taxes.

There are three categories the IRS uses to classify real estate investors:

  1. Passive Investor

Passive Investors can deduct passive losses against passive gains.

  1. Active Investor

Active Investors can deduct an additional $25,000 of losses against ordinary income, but this deduction phases out at the Adjusted Gross Income (AGI) level of $150,000 for a married couple filing jointly and $100,000 for a single individual.

  1. Real Estate Professional

Real Estate Professionals can deduct 100% of all real estate losses against ordinary income, but to qualify, they must meet a three-part test-

  1. Spend the majority of their time in real property businesses

  2. Spend 750 hours or more in the industry of real estate or in the ‘real property business’

  3. ‘Materially participate’ in the management of the properties

Being classified as a Real Estate Professional is not necessary for all taxpayers and can have some downsides, including:

  1. If you are a Dealer, the IRS will hold you to higher standards to qualify for a 1031 exchange.
  2. If you are a Professional, your short-term gains and income in all of your real estate activities will be subject to self-employment tax.
The major benefit of being classified as a Real Estate Professional is the ability to deduct 100% of rental real estate losses against any other type of income. Read more about Real estate professional. 

Consider the strategy if you have rental property, but don't stress if you don't have any.

Always be aware of the different classifications and choose the one that best suits your needs and financial situation.

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