If you invest in real estate, you likely understand the impact that tax-efficient investing can have on your bottom line. There’s a qualification called Real Estate Professional Status, or REPS, that might help you significantly reduce your tax bill through smart tax planning while simultaneously building wealth. In this article, we’ll cover what REPS is, how it works, and why it could be a useful part of your tax strategy, even if you’re just starting out in real estate.
Now that you know why REPS matters, let’s break down exactly what it means in practice.
Real Estate Professional Status is a designation defined by the IRS that changes how your rental activities are taxed. Usually, rental real estate is considered a passive investment. This means that losses from your rentals cannot be used to offset taxes on other income, such as wages or business earnings, unless you qualify for specific exceptions.
If you qualify for REPS, your real estate activities convert to nonpassive. This means you can use your real estate losses to offset other types of income, which can lead to big tax savings.
How Do You Qualify for Real Estate Professional Status?
To qualify for REPS, the IRS requires that you meet both of the following tests for the year:
1. The 750-Hour Rule
You must spend at least 750 hours during the year working in real property trades or businesses in which you materially participate (more on material participation later). These hours must be for personal services (hands-on work, such as showing units or collecting rent) that involve direct participation in the activity. Examples include:
- Managing your rental properties
- Overseeing repairs or renovations
- Negotiating leases or acquisitions
- Handling tenant communications
It is vital that you keep a time log that shows your hours are real and directly related to real estate work. For example, write down the date, what you did, and how much time you spent on each task, and keep records to prove each entry.
2. More Than Half of Personal Services
Besides the 750-hour rule, you also need to spend more than half of all your working hours on real property trades or businesses in which you materially participate. For example, if you have a full-time job outside real estate, that will almost always disqualify you. If you work 2,000+ hours during the year at your day job, you’d need to spend even more time on real estate to qualify, which isn’t realistic for most people.
This second rule is often the hardest part for people who work in another field. That’s why REPS is usually used by those who focus mainly on real estate or who can qualify through their spouse.
What Is a Real Property Trade or Business?
Section 469 of the IRC defines real property trade or business as any real property:
- Development
- Redevelopment
- Construction
- Reconstruction
- Acquisition
- Conversion
- Rental
- Operation
- Management
- Leasing
- Brokerage
These are the types of real estate businesses in which you would need to materially participate in order to count the hours spent towards the criteria for REPS. It’s important to note that short-term rental (STR) activities do not count as rental or leasing activities and, therefore, do not count towards REPS.
What Is Material Participation for REPS?
Spending time on a real property trade or business does not automatically mean you qualify for REPS, and all your real estate losses are suddenly nonpassive. You must also meet one of the IRS material participation tests for each real property trade or business in order to count the hours spent in that trade or business towards the REPS criteria.
There are seven different tests, but the most relevant for investors include:
| 500-Hour Test | You participate in the activity for more than 500 hours during the year. |
| 100-Hour and More Than Anyone Else Test | You participate for at least 100 hours and more than any other individual. |
| Substantially All Participation Test | You perform most or all of the work in the activity yourself. |
These rules are meant to stop investors from handing everything off to a property manager or contractor and still claiming REPS. You need to be actively and consistently involved for your activities to be nonpassive.
How to Track and Prove Your REPS Hours
The IRS expects you to keep detailed records if you claim REPS. One common mistake is forgetting to track your time as you go. The easiest method is to keep a log or spreadsheet that includes dates, hours worked,a brief description of each task, and proof of each entry. The IRS does not require a specific format. What matters is that your records are updated as you perform the activities, not months later.
You can use digital tools or apps to make tracking your hours easier. Even a basic spreadsheet works if you keep it up to date. The main thing is to have clear records to back you up if you’re ever audited.
Common Mistakes When Pursuing REPS
Many people think that simply owning rental properties makes them eligible for REPS, but that’s not the case. There are some common mistakes to avoid:
| Hiring a property manager | Not managing the properties yourself is a red flag when claiming REPS. |
| Not considering intricate tax laws | If you own multiple properties, you must make a formal aggregation election on your tax return to treat them as a single activity for material participation purposes. Transparently, this is not a DIY action step. |
| Failing to track time in real time | If you wait until the end of the year to see if you qualify, you might miss important details in your records. It’s much easier if you track your hours as you go. |
Qualifying for REPS is just one part of a bigger picture. Choosing the right CPA who provides ongoing tax advisory services, not just annual preparation, can make the difference in fully leveraging these benefits.
Strategies for Qualifying as a Real Estate Professional
Planning ahead is key if you want to qualify for REPS. Here are some helpful strategies:
- If you are married and file jointly, only one spouse needs to qualify for REPS for both to benefit. This allows one spouse to focus on real estate while the other maintains a separate career.
- By aggregating multiple rental activities into one, you can combine hours across properties. This can make it easier to meet the necessary thresholds.
- If you work with a tax professional early in the year, they can help you track your hours and avoid any surprises when it’s time to file your taxes.
How REPS Can Improve Your Real Estate Tax Strategy
The main benefit of qualifying for REPS is that you can turn passive losses into nonpassive losses to offset your other income. Without REPS, these losses are limited and might carry over for years. With REPS, you can use them to offset other income and lower your tax bill right now.
For example, imagine a taxpayer who earns $1,000,000 in W-2 wages and has a rental portfolio that generates $300,000 in tax losses via advanced tax planning. Without REPS, those losses are passive and cannot offset taxable W-2 income. With REPS, those losses can reduce taxable income by $300,000, resulting in $111,000 federal tax savings at the 37% bracket.
Final Thoughts
REPS can be a great benefit for investors, but it takes effort, good records, and planning. Meeting the 750-hour and more than 50% rules is just the start. Staying active and involved, and keeping clear records, will help you qualify with confidence.
If you think you might qualify for REPS or simply want to see how this strategy could work for you, let’s talk it through together. At Aiola CPA, we’re here to help you understand your options and build a tax plan that fits your real estate goals. Reach out, and let’s explore what’s possible for your situation.
Frequently Asked Questions About REPS
Q: What are the main benefits of qualifying for REPS?
A: You can use real estate losses to offset your ordinary income, significantly lowering your tax bill.
Q: Can I qualify for REPS if I have a full-time job?
A: Likely not. The requirements are strict: you must spend more time on real estate activities than any other job and meet the 750-hour requirement. A way around this is if your spouse does not have a full-time job and qualifies – one REPS qualification benefits both spouses.
Q: What is material participation for REPS?
A: Material participation means you are actively involved in managing and the day-to-day operations of your properties, not just a passive investor.
Q: How do I track my hours for REPS?
A: Keep a log or spreadsheet with dates, tasks, time spent, and proof. Update it regularly for best results.
