Real Estate Professional Status (REPS)

For real estate investors, the Internal Revenue Service (IRS) now offers significant tax benefits in the Real Estate Professional Status (REPS) designation. However, qualifying for and maintaining REPS requires careful adherence to specific criteria.

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What is Real Estate Professional Status (REPS)?

The IRS clarified REPS rules through Publication 925. This designation allows real estate professionals to deduct their financial losses in active real estate businesses, which would otherwise be viewed as a non-deductible loss in a passive income stream. To qualify, you must meet specific material participation and time requirements.

What are the benefits of REPS?

1. Offset Active Income with Rental Losses. By claiming REPS, real estate losses—such as depreciation, maintenance costs, and interest expenses—can offset active income like salaries or self-employment earnings. This can result in significant tax savings.
2. Maximize Depreciation Deductions. With REPS, investors can leverage accelerated depreciation, including bonus depreciation, on real estate assets. This strategy often results in substantial upfront tax benefits.
3. Tax Deferral Opportunities. REPS allows taxpayers to defer taxes by offsetting income now, which can free up capital for reinvestment or other purposes.
4. Improved Cash Flow. By reducing tax liabilities, investors retain more of their income, improving their cash flow and ability to grow their real estate portfolio.
5. Estate Planning Advantages. REPS benefits can be compounded when paired with effective estate planning strategies, helping to preserve wealth across generations.

How can someone qualify for REPS?

Properly claiming REPS requires meeting stringent requirements outlined by the IRS. These rules ensure that only individuals who actively participate in real estate activities qualify for the designation.

1. Material Participation. You must materially participate in your real estate activities, which requires being significantly involved in the operations of real estate ventures. The IRS provides seven different tests to determine material participation, but generally, you should participate in more than 750 hours of real estate work during the year or devote your full time efforts towards qualifying real estate matters.
2. Time Requirements. You must spend more than half of your total working hours in real estate activities, including property management, leasing (residential, commercial, or ground leases), development, construction, and similar work.
3. Real Estate Activities Must Be a Trade or Business. The real estate activities you engage in must qualify as a trade or business under IRS rules. Our firm can help you set up an LLC and manage the entity in compliance with REPS requirements.
4. Joint Filing. If you are married and filing taxes jointly, only one spouse needs to meet the REPS requirements. However, both spouses’ participation can count toward material participation in shared activities.

How can I prove REPS to the IRS?

Proving REPS requires meticulous record-keeping and documentation. The IRS has the power to dispute, investigate, or audit a taxpayer’s claims of REPS, so it’s essential to have detailed evidence if or when they ask. Here are helpful tips:

1. Maintain a Detailed Time Log. Keep detailed information about the date of your activities, the number of hours spent, and a thorough description of the activity.
2. Keep Your Supporting Documentation. Save any documents which support your time log entries, such as emails and communications with tenants or contractors, receipts for maintenance or investment expenses, and calendars or notebooks that track your work.
3. Differentiate Real Estate Activities. Ensure your records clearly show that the time you spent on real estate activities is different than your other non-real-estate work.
4. Use a Trusted Tax Professional. Work with a tax advisor or CPA who is familiar with REPS to ensure compliance, as well as help with audits.

REPS Risks

Claiming REPS increases your likelihood of being audited; the IRS regularly challenges REPS claims due to the high potential for abuse by investors. If you cannot substantiate a REPS claim during an audit, your claimed losses may be reclassified as passive income and cause additional taxes, penalties, and interest. Additionally, even though REPS allows you to defer taxes by offsetting active income, you may still face depreciation recapture when selling a property.

Real Estate Attorneys For Real Estate Investors

Whether you are just starting in real estate or are a seasoned investor, proper planning and guidance can help you fully capitalize on the benefits of REPS while minimizing the risks. The experienced real estate attorneys at Avenue Legal Group help real estate investors and professionals every day. Contact the firm to speak with an attorney.

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