Real Estate broker considered as Real Estate Professional for tax purpose?

[arbind3]

My wife is a full time real estate broker with John L Scott. We jointly file our taxes. We bought a rental property last year in November. We have a property management firm managing this rental. Do we qualify to be a Real Estate Professional for tax purpose?

[Carl]

According to what I find (and it's not on any official IRS website):

To be a real estate professional, a taxpayer must provide more than one-half of his or her total personal services in real property trades or businesses in which he or she materially participates and perform more than 750 hours of services during the tax year in real property trades or businesses.

[arbind3]

Turbotax shows the following for "Material Participation" test. Based on the test #6 below, it looks like we qualify as "Real Estate Professional" for our rental property given she is a full time real estate broker (so meets the 750 hrs test and 50% of time tests). But since we have a property management firm managing this rental, I have some doubts because of the line with message "if anyone (other than you) received compensation for managing the activity" below.

"

You materially participated in the operation of this business activity during the year, if you meet ANY of the following tests:

1. You participated in the activity for more than 500 hours during the tax year.

2. You are the only person who substantially participates in the activity, including individuals who do not have an ownership in the activity.

3. You participated in the activity more than 100 hours during the year and no one else participates more than you do, including individuals who do not have an ownership in the activity.

4. The activity is a significant participation activity, and you participated for more than 100 hours in each of several activities, and the total for all these activities is in excess of 500 hours.

5. If any of the above situations applied to you in any 5 of the last 10 years, you are deemed to have materially participated this year. (In determining if you materially participated in tax years beginning before 1987, you materially participated only if you participated for more than 500 hours during the tax year.)

6. If you materially participate in a "personal service" activity (child care, consultant, real estate agent, etc.) for at least three years, you are a material participant for life.

7. Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the tax year (you must have participated for more than 100 hours during the year).

However, your participation in managing the activity does not count in determining whether you materially participated if anyone (other than you) received compensation for managing the activity or if anyone spent more hours during the tax year than you performing services in the management of the activity.

8. If you are a retired or disabled farmer, you are treated as materially participating if you materially participated in 5 of the 8 years preceding your retirement or disability.

9. If you are a surviving spouse of a farmer, you may also be treated as materially participating in the farm, if the real property used for farming meets the estate tax rules for special valuation of farm property passed from a qualifying decedent and the surviving spouse actively manages the farm. (If you think you might qualify under this rule, contact the IRS for an explanation of those estate tax rules.)

If married, you can include your spouse's participation towards the 500 and 100 hour tests.

The work you performed must have been done at the time you owned an interest in the activity and must have been the type that an owner would customarily do in that type of activity.

"

[tagteam]

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@arbind3 wrote:

.....since we have a property management firm managing this rental, I have some doubts because of the line with message "if anyone (other than you) received compensation for managing the activity" below.

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You will most likely run into issues with the IRS if you are ever questioned about material participation if you employ a property manager.

[Mike9241]

You materially participated in the operation of this business activity during the year, if you meet ANY of the following tests:
6. If you materially participate in a "personal service" activity (child care, consultant, real estate agent, etc.) for at least three years, you are a material participant for life.
7. Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the tax year (you must have participated for more than 100 hours during the year).

However, your participation in managing the activity does not count in determining whether you materially participated if anyone (other than you) received compensation for managing the activity or if anyone spent more hours during the tax year than you performing services in the management of the activity.

certainly, she would meet 6  so 7 wouldn't matter except I think Turbotax misphrases what the actual rule is.

the activity is a personal service activity and the individual participated in it for any 3 prior years consecutive or not.   this would imply the need for material participation in the rental real estate activity. Temp Reg 1.469-5T

[tagteam]

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@Mike9241 wrote:\

certainly, she would meet 6  so 7 wouldn't matter except I think Turbotax misphrases what the actual rule is

the activity is a personal service activity and the individual participated in it for any 3 prior years consecutive or not.  

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I disagree. 

The activity here is a rental real estate activity (assuming no significant services are rendered to the tenants), not a personal service activity. Thus, the requirement of #6 is not met.

Unless more than 100 hours are spent on performing rental-related tasks on the property, such as repairs, cleaning, maintenance (and the like), the requirement of #7 is also not met (management and administrative tasks do not count toward the 100 hours).