Real Estate Professional Status: Qualification Rules & Tax Benefits

Real Estate Professional Status, or REPS, is a tax status under IRC Section 469 that may allow qualifying taxpayers to treat rental real estate losses as non-passive.

To qualify, a taxpayer generally must spend more than 750 hours in real property trades or businesses, spend more than half of their total working time in those businesses, and materially participate in the rental activities.

REPS is most valuable for investors with significant rental losses, cost segregation deductions, or business income, but it requires careful time tracking and documentation.

Can You Qualify for REPS? A Quick 3-Test Check

This video walks through the three core parts of qualifying for REPS:

• meeting the 750-hour test
• meeting the more-than-50% test
• proving material participation in your rental activities

It also explains why REPS matters for tax planning for high-income real estate investors.

When structured correctly, REPS can allow rental losses to offset W-2, business, and investment income, especially when paired with strategies like cost segregation and bonus depreciation.

Individuals who qualify for real estate professional status (REPS) receive significant tax benefits:

• Deduction of rental losses against other income, particularly valuable for those with high taxable income from other sources
• Accelerated depreciation on rental properties, enabling larger upfront deductions that improve cash flow in early ownership years
• Potential avoidance of the 3.8% NIIT by classifying rental income as active rather than passive.

Action Step: Consult with a tax expert to develop a strategy that leverages REPS benefits. Schedule a free consultation.

The major test you must satisfy to get real estate professional status is the material participation test.

Material participation means significant and continuous participation in the activity. First, you qualify for real estate professional status by meeting the 750-hour test and the more-than-50% test. Second, you must materially participate in your rental activities to deduct rental losses against ordinary income.

You must meet one of the seven criteria the IRS outlines for material participation (Temp. Reg. Sec. 1.469-5T(a)(1)):

1. The individual participates in the activity for more than 500 hours during the year.
2. The individual’s participation in the activity for the taxable year constitutes substantially all of the participation in such activity of all individuals (including individuals who are not owners of interests in the activity) for such year.
3. The individual participates in the activity for more than 100 hours during the taxable year, and such individual’s participation in the activity for the taxable year is not less than the participation in the activity of any other individual (including individuals who are not owners of interests in the activity) for such year.
4. The activity is a significant participation activity for the taxable year, and the individual’s aggregate participation in all significant participation activities during such year exceeds 500 hours.
5. The individual materially participated in the activity for any five tax years (whether or not consecutive) during the ten taxable years that immediately precede the taxable year
6. The activity is a personal service activity, and the individual materially participated in the activity for any three taxable years (whether or not consecutive) preceding the taxable year.
7. Based on all of the facts and circumstances, the individual participates in the activity on a regular, continuous, and substantial basis during such year.

Most people who qualify as real estate professionals satisfy the first test: participating in the activity for more than 500 hours in the tax year. Those hours generally also count towards the second test to qualify as a real estate professional, which is that you must spend over 750 hours working in a real estate trade or business.

These tests can be relatively complex and we encourage you to contact a qualified CPA to understand if you satisfy at least one of them. 

Recall from our two REPS statutory tests: for purposes of real estate professional status, you may only count personal service hours in real property trades or businesses in which you materially participate during a tax year. 

Personal service hours generally mean hours spent managing the day-to-day operations of the rental.

As provided by IRC Sec. 469(c)(7)(C), there are 11 real property trades or businesses:

1. Real property development
2. Redevelopment
3. Construction
4. Reconstruction
5. Acquisition
6. Conversion
7. Rental
8. Operation
9. Management
10. Leasing
11. Brokerage trade

If you’re involved in different real estate businesses, you can combine the time spent in those businesses for meeting the real estate professional status tests.

This means that you can be a real estate agent, a builder, and a property manager and count your aggregate personal service hours toward the “750” and “more than half your time” tests.

This grouping election is supported by Miller v. Commissioner, T.C. Memo. 2011-219 and CCA 201427016 but it should not be confused with the -9 election to group your rentals for purposes of material participation.

If you own a 5% equity stake in a real property trade or business, any service hours you perform may be considered real estate professional hours. If you provide services to the real estate industry (tax, law, money lending) then you may not be able to use those service hours toward REPS.

All hours logged must be personal service hours spent in a real property trade or business in which you materially participate. REPS hours and material participation hours are one and the same.

Said in another way: hours logged that are not personal service hours, or those spent in a non-material participation capacity, will not count.

You cannot log 500 service hours for a rental activity that you materially participate in and then log a random 250 hours of anything else. The additional 250 hours still have to be personal service hours spent in a material participation capacity. If you are logging hours simply to avoid the passive activity loss rules, those hours won’t count as participation.

What Hours Count vs. Do Not Count?

Participation hours in real property trades or businesses in which you materially participate are those that affect the day-to-day operations of the business.

If you’re reading this list and thinking “I basically have to self-manage my rentals” you would be correct. Qualifying as a real estate professional is not easy, and anyone who tells you it is should probably not be giving tax advice.

Here is our simple litmus test to keep you out of trouble: if the day-to-day operations of your real property trade or business and your rentals would be unaffected by the hours you are claiming on your time log, then those logged hours don’t count.

There are several common misunderstandings and mistakes we see when taxpayers attempt to qualify for real estate professional status (REPS). These typically involve how hours are divided, whether investor and education hours count, how travel time is treated, and the failure to make a proper grouping election.

Division of Hours

It’s 750 hours of personal service in a real property trade or business in which you materially participate. There’s no such thing as spending 500 hours of material participation hours on your rentals and an additional 250 hours of anything else.

Though a married couple filing jointly cannot combine hours for the purposes of the real estate professional tests, they can combine hours for purposes of material participation (IRC Sec. 469(h)(5)). This means one spouse can qualify as a real estate professional on their own and can then combine the non-real estate professional spouse’s material participation hours in rental activities to qualify jointly for material participation. 

Investor Hours

Time spent in the capacity of an investor will not count as participation in the activity unless the taxpayer is directly involved in the day-to-day management or operations of the activity (Temp. Regs. Sec. 1.469-5T(f)(2)(ii)).

Specific investor-related activities include:

• Studying and reviewing financial statements or reports on the operations of the activity
• Preparing or compiling summaries or analyses of the finances or operations of the activity for the individual's own use
• Monitoring the finances or operations of the activity in a non-managerial capacity

Other activities that may be deemed investor activities include organizing records, preparing taxes, paying bills, education, and research hours (W.A. Barniskis, 78 T.C. Memo 226, December 53,486(M), TC Memo 1999-258), (Padilla v. Commissioner, T.C. Summary Opinion 2015-38), (Jafarpour v. Commissioner, T.C. Memo 2012-165).

Hours spent “watching” contractors or “on-call” are not considered participation hours. This was detailed in Hairston v. Commissioner, T.C. Memo 2019-104. You must be actually performing services in order for your time to count as participation.

Education And Research Hours

Another hotly debated topic for real estate professional status is whether or not education and research hours count. It makes sense that investors want to log education and research hours because (1) these hours can amount to a lot of time, and (2) they are easy to obtain.

When you review the IRS Passive Activity Loss Audit Technique Guide and a few hundred Tax Court cases, you’ll come to the same conclusion we have: sometimes small amounts of education and research hours count, but most of the time they don’t.

The issue is overcoming the hurdle of education and research hours being characterized as “investor” hours.

A Tax Court case that most supports the fact that education and research hours won’t count is Jafarpour v. Commissioner, T.C. Memo 2012-165. The taxpayer in the case recorded a significant amount of time researching properties and attending classes and seminars on real estate investing.

In the Tax Court case Padilla v. Commissioner, T.C. Summary Opinion 2015-38, the taxpayer argued that he spent more time in real estate than anywhere else; however, his time log was found to be made up primarily of investor hours.

The Court also noted that the taxpayer logged these hours in an attempt to hit 750 hours because he had hired a day-to-day management company to manage his rentals and had little personal involvement.

Again, the Court is looking for activities involving the taxpayer in the day-to-day operation of the rentals, of which education and research are not.

It will be tough for you to substantiate that without your education and research hours, the renters would have stopped paying rent, bills would no longer be paid, and repairs and maintenance would have gone awry.

It’s just not a feasible argument to make.

Can Education And Research Hours Ever Count?

Theoretically, if your education and research hours directly impact the day-to-day operations of your business, they can be included as participation hours.

In Hailstock v. Commissioner, T.C. Memo 2016-146, the taxpayer owned numerous properties, didn't have outside employment, worked over 40 hours per week on stated properties, and used substantial amounts of her own resources to further her business.

Per the court case, Hailstock's duties included:

• checking messages for work orders,
• purchasing materials and cleaning supplies,
• supervising workers doing rehabilitation work,
• meeting with and conducting background checks on prospective tenants,
• executing leases,
• handling complaints regarding existing tenants,
• collecting rent payments from tenants,
• searching for new properties to purchase as real estate investments, and
• taking real estate classes for continuing education.

The Tax Court didn’t comment on whether searching for new properties or taking real estate classes were participation hours. However, we feel it’s safe to say that because the taxpayer was running his rental business full-time and participating in a significant manner, the education and research hours likely qualified as participation hours. 

Another way to think about education and research hours is: if you are legitimately a real estate professional, your substantial participation in your real property trade or business will get you over the 750-hour threshold alone. If education and research hours are a major factor in whether you meet the 750 hours and more than half your time tests, you’re skating on very thin ice.

Travel Time

The IRS’s position is that travel time does not count as participation hours in a real property trade or business.

As detailed by the IRS Audit Technique Guide:

Travel time generally should not be considered in computing the hourly tests for material participation, particularly if other factors indicate the taxpayer is not participating in the activity on a regular, continuous and substantial basis. 

Legislative history provides that "services must be integral to operations". It is somewhat difficult to construe that travel constitutes "services" or "participation" as contemplated by Congress or the Regulations. 

The Tax Court doesn’t necessarily agree, however. In Leyh v. Commissioner, T.C. Summ. 2015-27 the taxpayer recorded only 632.5 hours on her time log, but explained during audit that she had failed to record the time spent traveling among her 12 rental properties. The IRS countered that her log was inclusive of travel time, but based on her testimony at trial, the Court found that she had not included travel time in the time log.

Grouping Election

Major trap: without making a grouping election, you must materially participate in each rental activity separately. 

To get around this issue, we can group all rental activities into one. We then just need to demonstrate material participation in the aggregate. 

The grouping election is found in Regs. Sec. 1.469-9 and requires a formal election statement to be attached to your tax return in the year of making the election. This will group all rentals into one activity for purposes of Section 469. The election is binding for all future years, and all future years' rental activities are automatically added to the group. 

Proceed with caution, though. This grouping election can create problems if you have suspended passive losses. When you sell a property in a group of properties, you may not have disposed of “substantially all” of the activity, which will limit your ability to claim losses upon sale.

1. Partner with Your Spouse

The IRC requires more time to be spent in real estate than your W-2 job to qualify for REPS.

Importantly, the requirement is to exceed the number of hours worked at your job. Even if your schedule is 5 days on, 5 days off, what matters is exceeding the total number of hours spent at your job. If you have a full-time job requiring 2,000 hours a year, you cannot qualify for REPS. But your spouse can.

If they don't have a full-time job, REPS becomes much easier to achieve. As long as they work 750 hours and more time in real estate than a job, they can qualify for REPS.

2. Time Your REPS Election Strategically

Real estate professional status is evaluated annually. Hours do not carry forward or backward.

Let's assume you read this guide and you know you can't qualify for REPS this year. But you also know you are leaving your job next year or will take a sabbatical. You can take it easy this year and self-manage everything next year.

In the year you qualify for REPS, you can retroactively cost segregate your properties and claim all the missed depreciation by filing a Form 3115 with a 481(a) adjustment and effectively granting you large tax losses in the year you want to qualify as a REP. This is very complex, but can be done.

3. Run a Separate Real Property Business in Addition to Being a Landlord

If you are a small landlord, and that’s your only real property trade or business, it will be very difficult for you to substantiate your REPS election. 

One solution is to start a separate real property business to accumulate REPS hours. Maybe you start flipping or developing homes. Perhaps you become a real estate agent (note: getting a license in and of itself will not help you qualify for REPS, but representing buyers and sellers will).

Because REPS is based on time spent in all real property trades or businesses, you can more easily hit the hour tests if you are running multiple real property trades or businesses. And then, you just need to demonstrate that you also materially participated in the rentals. 

4. Buy Local and Hit the REPS Tests on a Rehab

Many investors invest out of state, but this creates a problem for substantiating any REPS hours or material participation. One solution is to buy a property local to you that requires significant rehab.

If you GC the project, pull permits, staff contractors, buy and deliver materials, perform quality inspections, and even do some of the work yourself, you can potentially log a significant amount of time (ideally 500+ hours). You’d then make the -9(g) election to group this rehab project in with all other rentals you own and, if you hit 500 hours on the rehab rental, you will be materially participating in the entire group. 

Make sure to rent the property out by year-end; otherwise, it’s not a rental activity, and all time is lost. And if it happens in the future, 5 years from now, when you do get audited, you’ll be thanking yourself.

Multi-Year REPS Planning

Real estate professionals may only need to own one property to materially participate in a rental activity. There’s nothing in the REPS tests about how many properties you must own to achieve REPS and demonstrate material participation in your rental activity. Meeting REPS depends on qualification and documentation.

Examples

Smith v. Commissioner, T.C. Summary Opinion 2014-112:

The taxpayer was a 63-year-old disabled veteran. He had no other job due to being disabled and made himself available 24/7 to take care of his one three-unit property.

Four things Smith had going for him in his Court case, though not made explicitly clear by the Tax Court: 

1. His only job was maintaining his rental property.
2. He was the property manager and performed all tasks himself.
3. His property was a 3-unit property (typically tenants are not in charge of maintenance on multi-family properties compared to their single-family counterparts)
4. His tenants didn’t do much to keep the place up which required the landlord’s constant micromanaging. 

The Court agreed that he qualified as a real estate professional even though he only had one property. 

Flores v. Commissioner, T.C. Memo 2015-9:

The taxpayer spent 1,295 hours working at a pavement striping business and had to overcome these hours to meet the second statutory test for real estate professional status. The taxpayer had one rental property, and even though the taxpayer did everything himself, his time log showed only 799 hours. 

The taxpayer contended that he had a second calendar that showed the additional hours needed; however, the Tax Court did not find the testimony credible. 

The issue, in this case, was that the taxpayer couldn’t show he spent more time in real estate than his 1,295-hour day job. His time log and testimony weren’t found to be credible.

Though the taxpayer may have felt that his rental activity was definitely not passive, what a taxpayer feels and what constitutes tax law are often very different results. 

The IRS's Position

It’s also important to show you what’s in the IRS Passive Activity Loss Audit Technique Guide. This Guide documents the IRS’s position and gives you insight into how they will challenge your position on real estate professional status and material participation in your rental activities. 

Specifically in the Guide: 

Indicators that the taxpayer did not materially participate: 

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

You’ll see we highlighted a handful of bullet points above. We believe these will be the biggest points of contention for landlords with small portfolios. 

How will you substantiate your position, knowing that the IRS is honing in on these issues?

Record-Keeping and Documentation

We require all of our clients, regardless of whether they are primarily involved in real estate investing or not, to maintain contemporaneous time logs or a daily calendar. In the event of an audit, we’d rather be in a position where we shift the burden of proof back to the IRS than the other way around. 

Though you don’t technically need to maintain this log daily, the Tax Court has previously held that the IRS is not required to accept a ballpark guesstimate of your hours (Hill v. Commissioner, T.C. Memo. 2010-200, aff'd, 436 Fed. Appx. 410 (5th Cir. 2011)) (Gragg v. United States, Case No. 14-16053, CA9).

You can prove your involvement by any reasonable method. The best way to do this is by having contemporaneous daily time reports, notes, emails, receipts, calendar appointments, and credit card/bank transactions.

If real estate is not your sole gig, you also need to keep a time log detailing how much time you spend in your non-real estate activities. This is critical to meet the “more than half” of your time test to qualify as a real estate professional. 

Recommended Checklist

☐ Time logs
☐ Calendars
☐ Emails and communications
☐ Invoices and receipts
☐ Contractor records
☐ Property-management records
☐ Notes supporting specific work performed
☐ Records of non-real-estate working hours, where relevant

Time Log Credibility

Not only is it important to log both your real estate professional hours and any hours spent in non-real estate activities, but it’s also critical for maintaining REPS to be a credible witness.

If you read through real estate professional Tax Court cases, you’ll find that a common word used in issuing opinions is “credible.” The Court will have you and other witnesses testify. If you can recall extensive details about your activities, you will appear more credible than not (for example, Zarrinnegar, et al v. Commissioner, T.C. Memo 2017-34). 

Examples to Review

• In Escalante v. Commissioner, T.C. Summary Opinion 2015-47, the Court held that the taxpayer’s time log was not credible.
• In Hairston v. Commissioner, T.C. Memo 2019-104, the Court found that the taxpayer inflated his time log and did not grant real estate professional status. 
• In Lee v. Commissioner, T.C. Memo. 2006-193, the taxpayer’s time log showed spending 24 hours to replace blinds, 56 hours to replace a toilet, and over 280 hours to close year-end books. The time entries were found to be unrealistic and not credible. 

→ Keep detailed and credible records of your real estate, investing, and non-real estate activities. Click here to download our time log.

To understand why REPS matters, it helps to understand how the passive loss rules limit a taxpayer’s ability to claim losses from a passive activity.

IRC Section 469 defines a passive activity as:

1. Any trade or business in which the taxpayer does not materially participate, and
2. Any rental activity except as provided under IRC Section 469(c)(7). (IRC Sec. 469(c)(1) and (c)(2)).

Thanks to the second point, all rentals are considered passive by default.

Passive rental losses can only offset net passive income or gain on sale from other passive activities (IRC Sec. 469(b)). Excess passive losses are suspended and carried forward.

There are three key exceptions to getting around the default rule that all rental activities are passive:

• On the entire disposition of an asset in a fully taxable transaction, both the current and suspended losses can be used to offset wages, portfolio, and other non-passive income (IRC Sec. 469(g)).
• Rental real estate losses up to $25,000 may be deducted by an individual whose modified adjusted gross income is less than $100,000 (IRC Section 469(i)(2)).
  • To qualify for this offset, the taxpayer must actively participate, own at least 10% and not be a limited partner. The $25,000 exception is phased out at the rate of $0.50 for every $1 of modified adjusted gross income over $100,000. Therefore, when modified adjusted gross income exceeds $150,000, the $25,000 offset is not allowed.
• Qualify as a real estate professional under IRC Section 469(c)(7). This exception establishes the importance of achieving Real Estate Professional Status.

Prior to 1986, taxpayers could deduct losses related to their rental real estate activities in full against their other income, regardless of their level of participation. This allowed high-income earners to shelter their ordinary income with non-economic losses from real estate.

The Tax Reform Act of 1986 added IRC Section 469 which eliminated this tax shelter for landlords. The tax code under Section 469 restricts how much rental losses you can deduct when you aren't actively involved.

As a result, a taxpayer could only use passive losses generated from rental activities to offset the taxpayer’s passive income (IRC Sec. 469(d)(1)). This dealt a huge blow to high-income earners who subsequently saw a sharp rise in their tax liabilities.

While IRC Section 469 curbed the passive loss tax shelter for the rich, it unintentionally punished taxpayers running real estate businesses. For example, a builder could construct a handful of properties, sell some, and keep the others as rentals for rental income, but could no longer write the rental losses off against the income from the sales.

Recognizing this issue of inequity, Congress took action.

Beginning in 1994, IRC Section 469(c)(7) was added to the Code. This section allows taxpayers qualifying as real estate professionals to deduct all rental losses regardless of how high their Modified Adjusted Gross Income might be.

The intent of adding this section was to allow taxpayers who are primarily participating in real estate activities to deduct losses.

The short-term rental (STR) loophole and Real Estate Professional Status (REPS) are two distinct strategies that allow rental real estate losses to be treated as non-passive, but they have very different qualification requirements. The STR loophole applies to properties with an average rental period of seven days or fewer (or 30 days or fewer with substantial services provided) where the owner materially participates; when these criteria are met, losses may offset active income without the taxpayer qualifying as a real estate professional.

This makes STRs a potential option for W-2 employees and business owners who cannot meet REPS standards. In contrast, REPS requires a taxpayer to spend more than 750 hours and more than 50% of their total personal service time in real property trades or businesses in which they materially participate, making it generally impractical for full-time W-2 employees. While STRs often offer higher income potential but require active, hands-on management and may produce less predictable cash flow, REPS typically aligns with full-time real estate operators managing longer-term, more stable rental portfolios.

Read more about Short-Term Rentals vs REPS.

For a real estate professional status (REPS) election, you're primarily looking at three things: whether you qualify for REPS, whether you materially participated in your rental activities, and whether you have credible documentation to prove it.

Understanding these areas of scrutiny can help you prepare your records and substantiate your position before an audit occurs.

Let’s now discuss how an IRS agent will audit your real estate professional election. Knowing the process and what they will look at can help you piece together your case and substantiate your REPS election. 

In our experience, real estate professional audits can sweep across a CPA’s client group. 

For example, a CPA is playing loose and fast and claims REPS for clients even though they can’t possibly win because they are logging large amounts of non-participation (education and research, investor hours, etc.) hours to meet the 750 hour test.

An IRS auditor reviews one client’s file, denies REPS, and then pulls three more clients from that CPA’s group. If none of them qualify as REPS, guess what happens next? All clients can get pulled for an audit. 

Unbelievable? We have personal experience helping clients from a CPA firm where this exact scenario played out. 

It’s absolutely critical that you work with a CPA who confidently tells you what you need to hear, not what you want to hear, about qualifying and substantiating real estate professional status. 

Let’s talk about IRS audit execution. 

The IRS is going to first attempt to determine whether any of your rentals are excluded from the definition of a rental activity under IRC Sec. 469.

Once the IRS has bucketed your rentals between those that are excluded from the definition of a rental activity and those that are included, they will begin analyzing your participation in your rentals. Any rentals under a third party property management firm will be heavily scrutinized.

Here’s an excerpt from the Audit Technique Guide: 

A taxpayer, who does most of the work in a rental, meets Test 2 for material participation in Reg. § 1.469-5T(a)(2). However, if there is on-site management, it may be difficult for the taxpayer to materially participate because: 

• Rental activities, by nature, normally do not require significant day-to-day involvement, i.e. they are not time intensive. 

• For many taxpayers using any kind of outside management, the only material participation test available is the 500 hour test. In many situations, the other tests will not apply. 

• In many circumstances, an individual rental activity will not require 500 hours of participation, nor will the taxpayer have sufficient time available to spend 500 hours on each individual rental real estate activity. 

Common Areas of IRS Scrutiny

• Credibility of time logs.
• Conflict with full-time employment.
• Investor activities counted as participation.
• Inflated or unrealistic hours.
• Property-manager involvement.
• Material participation by activity.
• Grouping-election treatment.

Participation Examination 

• During the initial interview, question the taxpayer regarding time spent in all activities (personal, business, civic, family, hobbies, etc). 

• Request and closely examine the taxpayer’s documentation of time utilized for material participation in each activity. 

• Look for time spent by others in the activity. Indicators: commissions, management fees, expenses for cleaning, maintenance, repairs, etc. 

• Tie down the taxpayer’s day-to-day involvement and specific hours regarding the activity.

• Request, as soon as possible, a log or other documentation itemizing the nature of the participation and the hours for each type of work claimed during the year. 

• Request a copy of any management or commission agreement. Frequently, there is little left for the taxpayer to do. 

• Refer to Chapter 4 if significant time claimed for reading reports, paying bills or other active investor-type hours, which are generally disregarded in the material participation tests.

• Verify that one spouse alone meets BOTH of the following tests

• Are more than 50% of services (personal) in businesses for the year performed in real property trade or business and rental real estate?

•  Does taxpayer spend more than 750 hours in real property businesses and rentals in which he materially participates? 

Interview Questions

• Describe the work you perform as a real estate professional. Check occupations by signatures and W-2s. 

• Who is the real estate professional, you or your spouse?

• Does the spouse claiming to be the real estate professional work full-time or part-time? If the taxpayer has a full-time job working 2080 hours a year in a non-real property business, he must work 2081 on his real property businesses to meet half-personal services test!

• What percentage of each real property business(es) do you own? Unless taxpayer owns 5 percent or more, time is not counted. See IRC § 469(c)(7)(D)(ii). If, for example, the taxpayer works full-time for a construction company, but does not own any of the company, he is not a real estate
  professional. 

750 Hour Test 

Time does not count for purposes of the 750 hour test and the half personal services test – unless the taxpayer materially participates in the activity. One spouse ALONE must meet the 750 hour test.

• Who performs the services, husband or wife? Hours by husband? Hours by wife?

• Approximately how many hours did you spend working on your rentals in the year under exam? Ask the taxpayer for supporting documentation (appointment books, diaries, calendars, logs, etc.) You may want to give taxpayer a log to be completed for each rental – and for each year under exam. Material participation is a year by year determination. Rentals are generally not time intensive.

• If non-working spouse claims to be the real estate professional, ask what other commitments he/she may have. Is the spouse a student? Is the spouse providing full-time care to young children? 

Material Participation In The Rentals

• Who monitors the rentals? Who collects the rent? Who does the repairs?

• Do you have an agent or manager or employee responsible for any of the rentals? Ask for each rental property. Check Schedule E properties for large commissions or management fees. Also check for large labor expense - 2-21 possibly a hired contractor spent more time than taxpayer. If there is paid management, it is a strong indicator taxpayer did not materially participate.

• Is anyone besides you involved with managing or overseeing any of the properties? Does a relative or friend manage/monitor the property for free?

• Does a tenant receive free/reduced rent for managing the rentals – or for caring for the properties? 

They will also review whether or not you made the grouping election for material participation purposes (Treas. Regs. Sec. 1.469-9(g)) to treat all rental activities as one activity. Without this grouping election, a taxpayer must materially participate in each rental activity separately. 

Grouping Election

• Question the taxpayer in the initial interview whether an election was made, grouping rental real estate interests as a single activity.

• Request a copy of the return with the election. Request the original Form 1040, U.S. Individual Income Tax Return, from the IRS Center if doubts exist as to the documents furnished. 

• Review prior and subsequent year’s tax return(s) for consistency.

• Closely scrutinize any income on Form 8582 line 1a. If the taxpayer is a real estate professional and did most of the work on the rental, gain on disposition does not belong on Form 8586.

Qualifying and substantiating real estate professional status starts with understanding how an auditor will assess your situation and your tax return. Review the above, especially the questions, and build support today that answer the questions. 

Throughout the guidance and the questions the IRS provides to auditors, you’ll notice they believe rental activities don’t require much time to manage. 

How will you overcome this presumption? How will you prove that you spent a significant amount of time managing and attending to your rentals?

The IRS does not play around with real estate professional status. It’s one of the most litigated pieces of the Tax Code. Get it right and you won’t be sorry later.

Action Step: Review the IRS audit process and prepare for scrutiny by maintaining comprehensive and credible documentation of your real estate activities, including detailed time logs, grouping election forms, and supporting evidence for material participation, to substantiate your real estate professional status and overcome IRS presumptions about minimal time requirements for rental management.

Do the hours spent on your short-term rental properties count toward real estate professional status?

Takeaway: While older court cases said short-term rental (STR) hours don’t count toward Real Estate Professional Status (REPS), the 2017 tax law changes created a strong argument that they now can, but it’s still a gray area.

STR hours did not count according to Bailey V Commissioner (Bailey v. Commissioner, T.C. Memo 2001-296 and Todd and Pamela Bailey v. Commissioner, T.C. Summary Opinion 2011-22, unrelated Baileys). However, in the Tax Cuts and Jobs Act of 2017, the definition of a Real Property Management was expanded to include ‘places of lodging’ like hotels and motels, places similar to Holiday Inns.

The tax definition of a hotel also mirrors short-term rentals. While court case history presents a different model, legislative intent should and does trump prior case law, which would mean that STR hours now count for REPS.

Clarity on Real Property Trade or Business

Takeaway: Not all real estate-related work counts toward Real Estate Professional Status, the key is that your services must be directly tied to a real property trade or business you materially participate in (and typically own ≥5% of if you’re an employee). Indirect roles (like mortgage brokers) generally don’t count, while a wide range of direct activities, even legal or appraisal work, can qualify depending on the facts.

Though the Regulations provide a baseline for what constitutes real property trades or business activities, we have to look to Tax Court cases and Chief Counsel Advice (CCA) rulings for further guidance. For example, what does “brokerage” mean? Is that a real estate broker or a mortgage broker?

In CCA 201504010, the IRS ruled that a mortgage broker was not engaged in a real property trade or business. The main reason for this determination was that a mortgage broker simply puts together lenders and borrowers, a service that is indirectly related to real estate.

It seems then that the IRS’s position is that services that count toward real estate professional status must be directly related to the real property trade or business in question. Services that won’t count are those indirectly related to such a trade or business.

Along those lines, in Calvanico v. Commissioner, T.C. Summ. 2015-64, the Tax Court and IRS agreed that the taxpayer, who was a licensed real estate appraiser performing appraisal work for an accounting firm, may be engaged in a real property trade or business. The taxpayer ultimately lost the case as they did not own at least 5% of their employer (IRC Sec. 469(c)(7)(D)) and therefore could not include any of the service time in their capacity as an employee.

But on the flip side, we have a case where an attorney was able to qualify as a real estate professional.

In Stanley v. United States (W.D. Ark. 11/12/15), the taxpayer owned a management company that managed his own rentals. He also provided legal services to his management company. The IRS argued that the legal services could not count toward real estate professional status but the Court disagreed. The Court held that the legal services did count toward real estate professional status because Section 469 does not specify the character of services performed to a real property trade or business, it just says services must be performed in a real property trade or business in which a taxpayer materially participates.

Theoretically then, as long as you own at least 5% of a real property trade or business, your time spent in that business will count toward real estate professional status, regardless of your role in the company. Interesting indeed...

It’s also important to point out that you don't technically need a professional license in order for the Tax Court to consider you being in a real property trade or business.

In Agarwal v. Commissioner, T.C. Summ. 2009-29 the Tax Court held that a real estate agent was considered to be engaged in a real property trade or business. The IRS attempted to argue that an agent was not a licensed “broker” and thus could not be involved in a brokerage trade. The Court sided with the taxpayer after reviewing the Webster definition of the term “brokerage” which is great news for real estate agents!

Working Full-time & Qualifying for REPS? That's a No.

Takeaway: To qualify for REPS, you must prove you spent more time in real estate than in your job. The Tax Court will closely scrutinize your hours and documentation.

In a Tax Court case Penley, et ux. v. Commissioner, T.C. Memo 2017-65, the taxpayer under scrutiny had worked a full-time primary profession and claimed real estate professional status during the year in question. The full-time job amounted to 2,194 hours, and the taxpayer produced a time log showing they spent an additional 2,520 hours on real estate during the year.

The Tax Court didn't believe Penley's time log, saying it seemed like a rough estimate instead of an accurate, daily record.

In Windham v. Commissioner, T.C. Memo 2017-68, the taxpayer was a part-time stockbroker and contended that she qualified as a real estate professional. She managed all aspects of her 12 properties including finding tenants, collecting rent, coordinating with repairment, maintaining insurance, maintaining services and upkeep, and maintained records detailing all of her activity. During 2010, she withdrew $180k from her retirement account to pay for rental expenses which further proved her commitment to her rental real estate portfolio.

The Tax Court sided with the taxpayer citing her substantial time spent on rental activities and her great records.

1. Why does REPS matter?

   REPS allows real estate professionals to treat losses from rental properties as non-passive, which means you can use them to reduce your other income, like W-2 wages or business income.

2. Can I still qualify for REPS if I have a full-time job?

   It's extremely difficult to qualify for REPS if you work full-time in another job because you need to spend more time on real estate than your other job.

3. What happens if I don’t qualify for REPS?

   If you don’t qualify as a real estate professional, any losses from your rental properties will be considered passive, meaning they can only be used to offset passive income, not your regular wages or business income. These losses are carried forward to future years.

4. Do the hours spent managing my short-term rentals count toward REPS?
   In the Tax Cuts and Jobs Act of 2017, the definition of a Real Property Trade or Business was expanded to include ‘places of lodging’ like hotels and motels, places similar to Holiday Inns. The tax definition of a hotel also mirrors short-term rentals. While court case history presents a different model, legislative intent should and does trump prior case law. STR hours now count for REPS.
5. What is 'material participation' and how do I prove it?
   To materially participate, you must meet one of the seven material participation tests, you need to be regularly and actively involved in running the real estate activity, and you must own a 5% stake in the employer. You can prove this by keeping a detailed time log that tracks your daily activities, such as property maintenance, tenant communications, or repairs.
6. Can I count research, education, or travel time toward my REPS hours?
   Education and research hours generally do not count toward REPS unless they are directly related to the ongoing management of your properties. Travel time may count if you are actively managing your rentals during the travel, but the IRS often scrutinizes this closely.
7. Can my spouse and I combine our hours to qualify for REPS?
   No, one spouse must meet the REPS hours requirement on their own. However, you can combine both of your hours to meet the material participation requirement for your rental properties.
8. How many properties do I need to own to qualify for REPS?
   You can qualify for REPS with just one property, as long as you meet the required criteria. Owning more properties increases your chances of meeting the hours needed for material participation, but it's not a requirement.
9. What is the 'grouping election' and why is it important?
   The grouping election allows you to treat all of your rental properties as one activity for tax purposes, making it easier to meet the material participation requirements. If you don’t make this election, you must prove material participation for each property individually.
10. Can I qualify for REPS one year and not the next?
    Yes, REPS is evaluated on an annual basis. You must meet the requirements every year, so if your involvement in real estate activities changes from year to year, your REPS status may also change.

How Do I Get it Right Alone? This is not an area that you want to venture into alone or without proper guidance.

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Blog Articles

• How High-Income Earners Can Benefit by Qualifying for Real Estate
  Professional Status
• How to Get Real Estate Professional Status
• How Many Hours Do I Need for Real Estate Professional Status
• How Many Properties Do I need to Own Before I Can Elect the Real Estate
  Professional Status?
• Real Estate Professionals: Avoiding Passive Activity
• REPS vs Short Term Rentals
• Qualifying as a Real Estate Professional and Deducting Passive Losses

Podcasts

• REPS 01: The History of § 469 (Passive Activity Losses) & Why it Matters to Real Estate Investors
• REPS 02: How You Can Offset W-2 & Active Business Income by Qualifying as a Real Estate Professional
• REPS 03: Strategies to Qualify as a Real Estate Professional & Busting the Myths of the Internet
• REPS 04: IRS Audits and Real Estate Professional Status
• REPS 05: What is the Real Downside to Grouping All of Your Rentals as One Activity for REPS?

Videos

• Will I Hit Real Estate Professional Status If I Get My Real Estate License?
• Will My W2 Hours Count Toward REPS? [Tax Smart Daily 027]
• How to Qualify for Real Estate Professional Status (And Save Taxes)

Tools

• REPSLog

Though this guide is thorough, it has been prepared for informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction or using any information in this guide for tax planning purposes.