Qualified to be a Real Estate Professional?
Real estate professionals may treat otherwise passive rental real estate activities as nonpassive if the taxpayer materially participates in the rental activity. Losses from such activities can be used to offset wages, interest, and other nonpassive income. This treatment is only available to eligible individual taxpayers and closely held C corporations who are considered to materially participate in the rental real estate activity. An individual is an eligible taxpayer for any tax year if [ IRC Sec. 469(c)(7)(B) ]:
1.more than 50% of personal services performed by the taxpayer in all trades or businesses during the tax year are performed in real property trades or businesses in which the taxpayer materially participates, and
2.the taxpayer performs more than 750 hours of service during the tax year in real property trades or businesses in which the taxpayer materially participates. This criteria requires actual performance of services.
Defining Real Property Trades or Businesses
A real property trade or business is broadly defined to include real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage [ IRC Sec. 469(c)(7)(C) ]. Reg. 1.469-9(d)(1) states that "depending on the facts and circumstances, a real property trade or business consists either of one or more than one trade or business specifically described in IRC Sec. 469(c)(7) ." This permits taxpayers to informally group together, if supported by the facts and circumstances, two or more of the 11 activities listed in the statute into one real property trade or business. This concept is further detailed in Chief Council Advice (CCA) 201427016. In it, the IRS permitted a taxpayer with a real property development trade or business and two rental properties to treat the three activities as one real property trade or business.
To be eligible for these special rules, the taxpayer must materially participate in real property trades or businesses rather than participate in business activities involving real estate transactions. This suggests that the benefits of these rules may be unavailable to individuals who are only peripherally involved in real property trades and businesses.
Material participation plays a role in two distinct aspects of the relief provision for real estate professionals. First, when determining whether a taxpayer qualifies as a real estate professional, only real property trades or businesses in which the taxpayer materially participates are counted for purposes of the 50% and 750-hour tests [ IRC Sec. 469(c)(7)(B) ; Reg. 1.469-9(c)(3) ]. Second, once it is determined that a taxpayer qualifies as a real estate professional, the nonpassive treatment is available only for rental real estate activities in which the real estate professional materially participates [ Reg. 1.469-9(e)(1) ]. Thus, a taxpayer must pass two material participation hurdles before a rental activity receives nonpassive treatment.