Real Estate Professional

[calcpa5]

I have a client having a dispute with the IRS regarding the definition of broker as it relates to real estate professional.

Are there any court cases or other definitions as to what constitues "broker of real property".

The IRS is claiming a real estate agent who has a Schedule C business and is licensed by the state of California cannot claim that time towards being a real estate professional because she does not have a brokers license and relies on Re-Max's brokerage license.

Please ask follow up questions if this is not clear.

Thanks.

[Bees Knees]

IRS Pub 925, page 5 says:

Real property trades or businesses. A
real property trade or business is a trade or
business that does any of the following with real
• Develops or redevelops it.
• Constructs or reconstructs it.
• Acquires it.
• Converts it.
• Rents or leases it.
• Operates or manages it.
• Brokers it.

Nothing is said in IRS Pub 925 that indicates “broker” means holding your own broker’s license.

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[Snaggletoof]

Double-Edged Sword

Is there another side to this coin?

If taxpayer is proving successful about being a "real estate professional" does this not also take away Capital Gains treatment on the sale of an investment house?

[abby]

Real Estate Professional Rules

I'm not sure I agree that each activity has to pass the real estate professional rules. A broker can meet the RE Pro rules just through their broker activity.

If you are trying to meet the rules through rental activities only - that would be different.

If you are a broker (as I handily avoid the agent vs broker issue) that has rentals, then your rentals would need to meet Material Participation rules to qualify. You can elect to treat all rental activities as one (this includes pass throughs that qualify) to meet the Material Participation rules.

This is not the same as aggregating the rentals reported on Schedule E with your Sched C. The court case deals with a schedule E situation where a taxpayer wanted to meet the rules through schedule E activity only.

As for Snaggeltoof's point - capital gains treatment - as long as they're not a dealer where the houses are inventory, not passive activities, all other treatment stays on Sched E, 4797 and D- the main risk is that you don't get preferential treatment in releasing losses, etc when a rental is sold because after aggregating you haven't disposed of the activity until the entire aggregate is disposed.

[Bees Knees]

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[Bees Knees]

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[abby]

maybe

the election is to combine all rental real estate activity - I still don't see that as electing to combine it with a schedule C - but maybe we mean the same thing - differently.

My point:

It is possible that you qualify as a real estate professional by your active trade and your rental acitivity or activities meet material participation rules each on their own - in which case no election would be required. You could treat them as non-passive by virtue of your qualification as a Real Estate Professional.

The key in that case is Material Participation

To qualify as a Real Estate Professional you need to meet two tests - and the tests don't say for EACH activity - the tests are spending more than half of your professional time in RE and spending 750 hours in real estate trades or businesses in which you materially participate. I think of it in two parts - first qualify as a REP and then see if you've met Material Participation rules in your passive activities. You may need to make the election for one or both, but not necessarily.


Unless I've really misread the rules. This, of course, is always possible.

[Bees Knees]

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[Bees Knees]

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[Bees Knees]

OK, I’m going to back track just a little.

Under Reg. Sec. 1.469-9(e), it states that Section 469(c)(2) does not apply to any rental real estate activity of a taxpayer for a taxable year in which the taxpayer is a qualifying taxpayer. The term qualifying taxpayer is one that meets the more than 50% personal services rule and more than 750 hour rule.

Under Reg. Sec. 1.469-9(b)(5), it defines material participation under Reg. Sec. 1.469-5T. That regulation is the normal material participation rules, meaning you either put 500 hours into the activity, or 100 hours and no one puts in more hours etc. etc.

So in other words, you are right, Abby, in that there are two hurdles that need to be met.

First hurdle: The taxpayer has to qualify as a real estate professional, meaning, the individual has to have at least one activity in which he or she spends more than 750 hours in and more than 50% of the time providing personal services.

Once that hurdle is met, then a rental real estate activity owned by the individual is no longer automatically a passive activity, IF, each activity passes the material participation rules, such as the 500 hour rule, or 100 hour rule.

The court cases cited without the election to group activities never got past the 750 hour hurdle since the taxpayer’s W-2 job was not related to a real estate activity. That meant the rental real estate activities had to pass the 750 hour test on their own, or be group together and pass the 750 hour test as a combined group. The example in the IRS Pub also is an example of a non-real estate activity (grocery store business) being group with a rental real estate business.

In the example of a real estate broker, the 750 hour test can be met in that activity since it is a real estate activity in itself. Therefore, any rental real estate activity is not automatically treated as a passive activity by reason of it being a rental under Section 469(c)(2). HOWEVER, each rental activity must pass the material participation test. In the context of that rule, the material participation test is the Reg. Sec. 1.169-5T test, meaning the 500 hour test, or 100 hour test, etc. This is still a difficult test, as a person has to do more than simply actively participate. It has to be material participation, a tougher standard than active participation. That’s why it helps to elect to group all rental activities as one activity so that it is easier to reach these material participation requirements for the rental real estate activities. But I retract my statement in the other posts that the rental real estate activities have to also pass the 750 hour test. They don't. They simply have to each pass the material participation test since the 750 hour test was already passed in the broker activity (or elect to be combined as one activity to make it easier to pass all these tests).

Sorry for the confusion.

[abby]

Bees

I hadn't seen your last response until just now - I'd left to ruminate and regroup - and had returned today with essentially what you have written from a BNA resouce. Whenever I got tangled in code and regs, it's amazing how I can usually find something clearly laid out in BNA.

In any case, thanks much for your post - it lays things out extremely well and I'm thrilled to know I wasn't misreading the rules all this time.

The fact is my biggest real estate clients had made the election in any case, but it's good to know I gave them correct advice.

Once again, thank you.

[Bees Knees]

Abby, thanks for sticking around to argue with me when I was wrong. Many times, people will back down when I say something, assuming I am always right. I’m not, so I appreciate it when you stick to your guns and force me to dig deeper into the rules. There are many twists and turns in tax law. The Pubs and instructions only scratch the surface. I usually look at them first, but as in this case, they don’t always specifically address the issue, and I need to read the regulations before the rule becomes clear to me.

[WhiteOleander]

Ok y'all. I've been following this so I can get this straight in my mind too. But, It still seems a little unclear.

Can you make up an example where they would qualify and one where they don't because they don't meet the material participation rule?

That rule seems to be the same as the other to me.

[Bees Knees]

Simple example: Joe is a real estate agent. Sells houses for a living. Spends way over 750 hours doing it. He is a real estate professional. He owns 1 rental house. Files Schedule E. Because he is a real estate professional, his rental property is not automatically passive due to the fact that it is rental. It is only passive if Joe does not materially participate. Assume Joe is an active participant in the rental activity since he makes management decisions such as approving new tenants, decides on rental terms, approves expenditures, and other similar decisions. But he does not materially participate because he spent less than 500 hours during the year at it, and he hired a repair guy to do all the repairs and a caretaker to do all the day to day stuff, and each of these individuals spent more time managing his rental unit than he did. Joe’s rental real estate activity is still a passive activity since he did not pass the material participation test. He can, however, deduct up to $25,000 in losses because he was an active participant, and his AGI is under $100,000.

[Bees Knees]

Same example with a minor twist: Joe is a real estate agent. Sells houses for a living. Spends way over 750 hours doing it. He is a real estate professional. He owns 1 rental house. Files Schedule E. Because he is a real estate professional, his rental property is not automatically passive due to the fact that it is rental. It is only passive if Joe does not materially participate. Assume Joe is an active participant in the rental activity since he makes management decisions such as approving new tenants, decides on rental terms, approves expenditures, and other similar decisions. He also materially participates because he spent more than 100 hours during the year at it, and he did not hire anyone else to help him repair stuff, or do caretaker type stuff. His participation was at least as much as anyone else’s participation. Because he is a real estate professional, his rental activity is non-passive, even though it is a rental.