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Recently I was asked for more information about what a Real Estate Professional is, and why investors should consider it. As this has many tax implications, I’ve asked fellow Rich Dad Advisor, Tom Wheelwright, for his thoughts on this important strategy, which is not to be confused with a Real Estate Agent. Here is what Tom has to say:

The biggest tax challenge for real estate investors are the passive loss rules. Under these rules, passive losses can only be used to offset passive income. A business activity is passive if the owner does not spend much time (typically less than 500 hours per year) participating in the business. The challenge for real estate investors is that losses from rental real estate are generally considered passive regardless of how much time the owner spends working on the real estate. There are two exceptions to this rule.

The first, which is very easy to achieve, is referred to as the “active participation” exception. Any owner who spends some significant time on his/her real estate investments during the year qualifies, at least where the owner directly owns the real estate (that is, not as a limited partner in a partnership). This could include reviewing reports from the property manager, researching properties to buy, or handling the financing of real estate purchases. The IRS has been pretty generous in allowing this exception. The active participation exception allows up to $25,000 worth of losses during the year from rental real estate to be treated as ordinary deductions not subject to the passive loss restrictions. This exception only applies, however, when the owner’s “adjusted gross income” (AGI) is not more than $100,000. If your AGI exceeds $100,000, then the $25,000 limit is phased out by 50 cents for every $1 the AGI exceeds $100,000. So, for example, if your AGI is $110,000, then the limit for that year will be $20,000 (or $25,000 minus $.50 x $10,000).

The second exception to the rental real estate passive loss rule is the real estate professional exception. The real estate professional exception is the “get out of jail free card” for real estate investors. If you meet this exception, then none of your rental real estate income and loss is subject to the passive loss rules. This is a much tougher exception to get than that for active participation, because you actually have to meet two criteria: 1) You spend more than 750 hours per year (which comes to about 14 ½ hours per week) as a “material participant” in a real estate business, which could include management, brokerage, construction, development, leasing, rental, and operation; and 2) You must spend more time in real estate businesses than all other businesses (including employment) that you’re involved in, combined. If you meet both of these criteria, then you qualify as a real estate professional.

The good news is that for a married couple, only one of the spouses has to qualify. But one trap here is that you still have to meet the passive activity rules for each property as if it were a regular trade or business. In other words, the real estate professional status only gets you out of the rental real estate trap. You still have to meet the 500-hour criteria for each property.

This could be a problem, since most people don’t spend 500 hours on a single property. The tax law provides a simple way around this. On your tax return, you may elect to treat all of your properties as a single property. This is called a Section 469(c)(7) election. The election is made on your personal income tax return. Doing so is permanent (and there can be some unintended consequences of electing to do this), so be sure to meet with your tax advisor before you make this decision.