Real estate professional and rental properties

[codad4x]

My wife is a real estate agent (independent contractor) and spends 750+ hours per year doing that.  She and I also own out-of-state rental properties, and she manages them all, including property management, tenant selection, leases, hiring people for maintenance and improvements, including traveling to do some of this work. I think of these as 2 separate activities, but I'm not sure if they are accounted for separately.

1) Does the time spent doing real estate and managing our rentals have to be accounted for separately?

2) Since she spends 750+ hours doing real estate, does it matter how much time she spends managing the rentals?

3) Do we need actual daily time logs for these activities, real estate and rental management?

4) Do we separate miles driven doing real estate from miles driven out of state to manage the rentals?

Finally, we are planning to set up her real estate LLC as an S-corp.  Will this impact how the rental property management is deducted?

Thanks for any assistance, or if you can direct me to appropriate IRS bulletins!

[tagteam]

The fact that your wife qualifies as a real estate professional is only the first step. 

The second involves material participation in each rental property (or aggregating the properties so that the material participation standard is met).

See https://www.thetaxadviser.com/issues/2017/mar/navigating-real-estate-professional-rules.html

Note that TurboTax does not support the aggregation of rental properties for this purpose.

[tagteam]

Generally, holding rental real estate in an S corporation is not the optimal method. 

One of the primary reasons for the foregoing is a distribution of one of the properties to a shareholder will trigger tax on any gain (distributions from a partnership (or multi-member LLC that defaults to one) to a partner will not trigger tax on any gain until the property is actually sold).

See https://www.therealestatecpa.com/blog/rental-real-estate-never-corporation

[Mike9241]

see this article it provides info on what the IRS is looking at to determine if a taxpayer is a real estate pro.

https://www.inman.com/2013/04/26/how-the-irs-defines-real-estate-pro/ 

Finally, we are planning to set up her real estate LLC as an S-corp.  Will this impact how the rental property management is deducted? this can be an extremely bad idea. in an LLC you can use the mortgage balance (non-recourse financing)  to determine your basis to see if it there is sufficient basis to absorb losses.  Mortgages and other debt except for the debt to the shareholder does not qualify to be added to their tax basis.    for example, an S corporation buys a building for $100,000 the shareholder puts in $20,000 and gets a mortgage for $80,000. the property losses $30,000. the taxpayer can only deduct $20,000 of losses because the mortgage doesn't count. if the $80,000 was a personal loan from the shareholder that would count and $30,000 could be deducted.  the downside . the S-Corp would have to pay the shareholder interest on the loan.   there is also an issue as to whether the S-Corp would have to pay the shareholder a salary.  most likely yes because she is performing services.  finally Real Estate Professional applies to individuals. doubt whether an S-Corp would pass muster and thus she would not be for income tax purposes.

before doing a conversion to an S-Corp consult with a tax pro.

[codad4x]

Very helpful information and articles!

A couple additional questions:

1) The reason I was thinking about the S corp for my wife's real estate business is I'm reading that it reduces the self-employment tax paid when it's based on her salary in the corporation.  For example if her profit is $100k, as a sole proprietor she would pay $15,300 (15.3%) SE tax, but in an S corp say she takes a salary of $50k with the other $50k in distributions, she only pays $7650 SE tax.  Is this correct?

2) If so, can we just keep the rentals as our personal passive income investment, outside of the S-corp?

[tagteam]

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@codad4x wrote:

....if her profit is $100k, as a sole proprietor she would pay $15,300 (15.3%) SE tax, but in an S corp say she takes a salary of $50k with the other $50k in distributions, she only pays $7650 SE tax.  Is this correct?

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That is not exactly correct since she the S corporation will have to pay her a reasonable salary for services rendered to the corporation.

Considering she provides virtually all of the services to the corporation that result in the corporation being profitable, her salary will (or should) be close to 100% of the profit.