- Hey, Clint Coons here with Anderson Business Advisors,
and in this video we are going to discuss
what it takes to be a real estate professional.
Alright, let's get started.
(uplifting rock music)
Okay, now you know if you watched a lot of my videos,
I talk mainly from the asset protection side,
be it with LLCs, corporations,
structuring deals with these entities, four year investing,
and every once in a while I'll delve onto the tax side.
So I thought in this video,
we'd maybe shift it up a bit,
and talk about real estate professional status,
because I get a lot of questions on this.
People wanna know, what does it mean
to be a real estate professional?
Does that mean I'm a dealer in real estate
and I need to structure myself a little differently
than I normally would to avoid higher taxes?
So I thought, well, you know what?
Let's just cut a video and nail all those questions
for you individuals out there that are considering,
can you be a real estate professional?
So let's start off by answering,
what is a real estate professional?
So real estate professional is someone
who spends 750 hours a year,
750 hours a year on real estate related activities.
So that, so it's a multi-pronged test here.
You gotta spend 750 hours a year,
and you have to spend 50% of time,
okay, on real estate related activities.
So there's a lot of confusion around this.
750 hours, got it, right?
You just add them up.
So if you wanna be a real estate professional
and again, I'll explain what that is
and why you wanna be in a second,
if you wanna be a real estate professional,
then you gotta meet this 750 hour test, okay?
So you just document all the time.
So you're driving out, looking at properties,
researching properties on the internet,
managing real estate.
Maybe you're in a profession where it's real estate related.
Keep track of all that time.
It's critical that you have a time sheet
that is made contemporaneous to when
you engaged in the activity,
not two years later when you're involved in the audit.
You're saying, well, you know what?
I have a photographic memory,
and I can remember everything I did going back 30 years.
No one's gonna believe it.
Second thing is this, 50% of your time.
So as I stated, this is the easy prong of the test to meet.
This is the more difficult prong.
Because when we talk about 50% of your time,
they look at whether or not you have another full time job.
So if you're working 40 hours a week as alignment,
then you would never qualify under this test
because they would say you have 750 hours,
but you can't satisfy the 50%
because you have that 40 hour job
that's non real estate related.
So in order to qualify as a real estate professional,
you also have to work, or maybe you don't work,
but if you do, you have to work part time in that other job.
So I've dealt with this before.
I've seen cases where it's a fireman,
and the fireman worked three days a week
for 40 hours a week as a fireman.
And then he went out and worked
real estate the rest of the time.
Tax court held not a real estate professional
because he had a full time job.
It's almost as if they don't even
pay attention to anything else.
All they say is, if you have a full time job,
you can never meet the test
because you can't satisfy the 50% of your time.
So why would someone actually consider
being a real estate professional?
Well, it comes down to tax benefits, that's it.
When you're a real estate professional,
you're able to take all of your real estate losses
that you generate from your activities.
And so, hold the bus there,
I'm not talking about the fact
that you're a bad real estate investor
and everything you invest in you lose money on.
What I'm referring to are the paper losses
that come to you through depreciation on your property.
I mean, real estate is a tax shelter.
That's why we invest in it.
So for example, if I have a house here
and it generates for me 20K in income,
okay, rental income, but I depreciate it,
'cause you're allowed to depreciate real estate.
You have to depreciate it.
So if I take my depreciation on this house is $12,000,
then I have $8,000 in positive cashflow or taxable income.
My positive cashflow is actually 20K
because the depreciation isn't anything
you paid out of your pocket,
it's just a deduction you're allowed to take
representing the diminished value on this asset over time.
So you're only paying tax on 8K.
Now in some situations, what happens
is that the depreciation is more than the income,
and that that will occur when you accelerate.
Maybe you're gonna do a cost segregation study
on your property, and it comes back and they tell you,
alright, well, we've done a cost segregation.
So your depreciation this year is $42,000
because we've accelerated what you're depreciating.
So now on your tax return, you show a negative $22,000 loss.
So what do you do with that loss?
Well, if you're an investor,
you look for other related income
that you can use it against.
So if I have income from other properties, my other rentals,
they throw off a combined positive income of 30K,
then I will match these two up,
and again, I'm back to showing $8,000
in positive income, taxable income.
But really, what did I take in?
I took in 30 here, 20 here.
So I brought in 50,000 bucks,
but I'm only paying tax on eight.
See the tax shelter component here?
But if you have, if you don't have this other income,
or maybe you did a cost segregation
on all of your other properties,
and over here you show a negative $60,000 loss.
So combined, We have $82,000 in losses.
What do we do with that?
Well, if I'm working and I'm generating
$200,000 in income this year,
what would be great is if I could
take that $82,000 against this $200,000 in income,
and then I would only show $118,000
in taxable income for the year.
I know you'd love to do it, but the IRS,
the internal revenue code does not allow us to do that,
with one notable exception:
if you are a real estate professional,
or you meet this status, alright?
So if you meet the real estate professional status,
then you can take it.
And so that drops us back down here again.
We've gotta meet this test right here,
but in order for you to earn that $200,000,
you're working full time, you're out of the game
it won't apply.
So then what do we do?
Well, number one, maybe you go part time.
If you go part time, instead of making $200,000,
you make $100,000.
Well, then you could take that 82 against the 100K.
And how much would you show?
$18,000 in taxable income for the year,
because now you can satisfy the test.
As long as you can show 750 hours and 50% of your time
you've met the test.
Make sense?
Hopefully.
The other thing to consider, if you can't go part time,
so here you are, you're right here.
You can't go part time, it's not gonna happen.
Say you work at Dell, you're an important engineer,
no way you can go part time
and you're making $400,000 a year.
Your spouse.
There we go.
If you're married, why not have your spouse qualify?
So if your spouse isn't working full time,
then your spouse could potentially
qualify as a real estate professional.
If your spouse qualifies as a real estate professional
and you file a joint tax return,
you've just fixed your issue now.
So in this case, we'll take the 82
apply it over here against the 400,000,
and now we'll show $318,000 in taxable income.
That move right there saved you about $24,000 in taxes
by having my spouse qualify,
and I still maintain my full time job.
So real estate professional status,
what it's designed to do for you
is free up any real estate losses,
because we work with a lot of people
who wanna go through their properties
and accelerate the depreciation,
and pull in all these losses
to offset high taxable income years.
But the problem is, is that it's not
real estate income that we're dealing with,
and we're dealing with W-2 income from your employer.
It poses a challenge for us.
And so this is why, you know, I offer in all my videos,
if you look in the notes, a free strategy session
so that we can analyze your situation,
decide sooner rather than later
what type of changes should we be making for this year
so we can capture these types of tax deductions?
And we don't want them to just fly away
or have to carry them forward
until we eventually sell the property at some future date,
and then we get to go in and pick it up.
I mean, those are things that
when you're considering what to do with real estate,
there's a lot of tax benefits that can come from it.
And it's best if you can definitely take advantage of this.
So I did mention at the very beginning,
what about dealer status?
Dealer status has nothing to do
with real estate professional status.
Dealer status is obtained
when somebody buys property with the intent to sell,
and it actually is concerned with flippers.
So if you're flipping property,
then you need to worry about dealer status
because all of the income you bring in then
is considered to be active income
and will show up on your Schedule C
if you're doing it in your own name.
Now I've got plenty of videos
on flipping and using corporations.
And the reason we do that
is we don't want you to be tagged as a dealer.
So real estate professional
has to do with the investor side,
how we free up deductions so we can use those deductions
against our other forms of income.
Alright, everyone, I wish you the very best
with your real estate investing.
You got any comments, let me know in the section below,
and I'll be sure to get to those
and answer those questions for you, take care.
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