Understanding Real Estate Professional Status (REPS) and Material Participation

Before long-term rental losses can be deductible without being limited by the passive losses rules, the taxpayer must (a) qualify as a real estate professional and (b) materially participate in the rental activities.

To be considered a real estate professional, an individual must (a) spend the MAJORITY of his or her time AND (b) spend more than 750 hours in real property businesses, which include:

• Development or redevelopment

• Construction or reconstruction

• Acquisition or conversion

• Rental

• Management or operation

• Leasing

• Brokerage

To qualify for material participation, the taxpayer (and their spouse if married filing jointly) has to meet one of the below 7 tests, with #1, 3 & 7 being the most commonly used.

• The taxpayer works 500 hours or more during the year in the activity.

• The taxpayer does substantially all the work in the activity.

• The taxpayer works more than 100 hours in the activity during the year and no one else works more than the taxpayer.

• The activity is a significant participation activity (SPA), and the sum of SPAs in which the taxpayer works 100-500 hours exceeds 500 hours for the year.

• The taxpayer materially participated in the activity in any 5 of the prior 10 years.

• The activity is a personal service activity and the taxpayer materially participated in that activity in any 3 prior years.

• Based on all of the facts and circumstances, the taxpayer participates in the activity on a regular, continuous, and substantial basis during such year. However, this test only applies if the taxpayer works at least 100 hours in the activity, no one else works more hours than the taxpayer in the activity, and no one else receives compensation for managing the
  activity.

Some indicators of non-material participation are as follows:

• The taxpayer was not compensated for services. Most individuals do not work significant hours without expecting wage or commissions.

• The taxpayer's residence is hundreds of miles from the activity.

• The taxpayer has a W-2 wage job requiring 40+ hours a week for which he or she receives significant compensation.

• The taxpayer has numerous other investments, rentals, business activities, or hobbies that absorb significant amounts of time.

• There is paid on-site management/foreman/supervisor and/or employees who provide day-to-day oversight and care of the operations.

•  The taxpayer is elderly or has health issues.

• The majority of the hours claimed are for work that does not materially impact operations.

• Business operations would continue uninterrupted if the taxpayer did not perform the services claimed.

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