Achieving Real Estate Professional Status (REPS)
To qualify for Real Estate Professional Status (REPS) with the IRS, you must meet two primary time-based tests and also demonstrate material participation in your real estate activities. The key is that your work must be active and substantial, not merely passive investment.
Here's a detailed breakdown with specific examples of what counts and what doesn't:
I. Qualifying Real Property Trades or Businesses (for the 750-hour test):
The IRS broadly defines "real property trades or businesses" as activities related to real estate. The work you do must fall into one or more of these categories, and critically, you must be actively involved in the operations.
Development or Redevelopment: This involves preparing raw land for construction or transforming existing properties.
Counts: Spending hours overseeing zoning applications, hiring architects for a new build, managing contractors during a major renovation to convert an old warehouse into apartments, or planning the layout of a new subdivision.
Doesn't Count: Simply holding land hoping its value appreciates.
Construction or Reconstruction: Building new properties or significantly repairing/rebuilding damaged ones.
Counts: Personally performing carpentry, plumbing, electrical work, or general contracting on a new home build or a major rehab project on a rental property. Supervising subcontractors on a construction site.
Doesn't Count: Paying a contractor to do all the work with minimal oversight from your end.
Acquisition: Purchasing or gaining ownership of real estate properties.
Counts: Actively searching for properties, negotiating purchase agreements, performing due diligence (like inspecting the property yourself or coordinating professional inspections), and arranging financing.
Doesn't Count: Hiring a real estate agent to find properties for you and only signing documents.
Conversion: Changing the use of a property.
Counts: Planning and executing the conversion of a single-family home into a duplex, or a commercial building into residential units. This involves hands-on planning, permitting, and construction oversight specific to the change in use.
Doesn't Count: Deciding to convert a property but not actively participating in the process.
Rental or Leasing: Managing and leasing residential or commercial properties to tenants. This is often the primary qualifying activity for many aspiring REPS.
Counts:
Tenant Management: Screening potential tenants, conducting background checks, showing units, drafting and negotiating lease agreements, collecting rent, handling tenant complaints, managing evictions.
Property Operations: Scheduling and overseeing routine maintenance (e.g., calling plumbers, electricians, landscapers), personally performing repairs (e.g., fixing a leaky faucet, painting, cleaning units between tenants), ensuring legal compliance (e.g., lead-based paint disclosures).
Financial Management: Handling bookkeeping, paying property taxes, procuring insurance, managing property finances. (Note: passive review of financial statements as an investor generally doesn't count, but active bookkeeping and financial management related to the property's operations does).
Doesn't Count:
Hiring a property management company to handle all day-to-day tasks with very little personal involvement.
Simply depositing rent checks.
Operation or Management: Day-to-day operations of properties, including maintenance, repairs, daily oversight, and collecting rent. This overlaps significantly with "Rental or Leasing."
Counts: Regularly inspecting properties, supervising on-site staff, developing operational budgets, and addressing urgent issues.
Doesn't Count: Being "on-call" without actually performing any services. For example, simply waiting for a tenant to call for a repair.
Brokerage: Activities performed by licensed real estate agents and brokers who facilitate property transactions.
Counts: Showing properties to clients, listing properties for sale or lease, preparing contracts, marketing properties, attending open houses.
Doesn't Count: Holding a real estate license but not actively engaging in transactions.
II. Time-Based Requirements:
You must meet both of these tests for the tax year:
More Than 50% Test: More than half of the personal services you perform in all trades or businesses during the tax year must be performed in real property trades or businesses in which you materially participate.
Example: If you work 2,000 hours in a year, and 800 hours are spent as a software engineer, you would need to spend at least 801 hours (more than half of 2,000) in qualifying real estate activities to meet this test.
Crucial Point: Your employee hours generally do not count towards the real property trade or business hours unless you own more than 5% of your employer. So, if you're a full-time W-2 employee, this test can be particularly challenging.
750-Hour Test: You must perform more than 750 hours of services during the tax year in real property trades or businesses in which you materially participate.
Example: If you spent 700 hours on qualifying real estate activities, you would fail this test, even if it was more than 50% of your total work time.
III. Material Participation:
Even if your work falls into the qualifying categories and you meet the hour tests, you must also materially participatein your real estate activities. This means you are involved in the operations of the activity on a regular, continuous, and substantial basis. The IRS has seven tests for material participation, and you only need to meet one (the first is most common for REPS):
More than 500 hours: You participate in the activity for more than 500 hours during the year.
Example: If you personally spend 550 hours throughout the year managing your three rental properties (tenant screening, repairs, rent collection, etc.), you meet this test for those properties. This is often the easiest test to meet if you are truly hands-on.
Substantially all participation: Your participation in the activity for the tax year constitutes substantially all of the participation in the activity of all individuals (including non-owners).
Example: You own a single rental property and do all the repairs, tenant communication, and financial management yourself, and hire no other assistance. You likely meet this test.
More than 100 hours and more than others: You participate in the activity for more than 100 hours during the tax year, and your participation is not less than that of any other individual (including non-owners).
Example: You own a duplex, spend 120 hours managing it, while your spouse spends 80 hours, and a handyman spends 50 hours on repairs. You meet this test.
Significant participation activities: The activity is a significant participation activity (more than 100 hours, but not otherwise materially participating), and your aggregate participation in all significant participation activities during the year exceeds 500 hours.
Example: You have three different real estate activities. In Activity A, you spend 150 hours; in Activity B, 200 hours; and in Activity C, 175 hours. None of these individually meet the 500-hour test, but since each is over 100 hours and the sum (150+200+175 = 525 hours) is over 500, you meet this test.
Prior material participation: You materially participated in the activity for any five tax years (whether or not consecutive) during the 10 tax years immediately preceding the current tax year.
Example: You ran a successful house-flipping business from 2018-2022, materially participating each year. Even if your activity is less intense in 2024, you might still qualify under this rule for your house-flipping.
Personal service activity: The activity is a personal service activity, and you materially participated in it for any three tax years (whether or not consecutive) preceding the current tax year. (Less common for standard real estate activities, more for fields like law or accounting where capital isn't a primary income-producing factor).
Facts and circumstances: Based on all the facts and circumstances, you participate in the activity on a regular, continuous, and substantial basis during the year (this is the most subjective and difficult to prove, especially if your hours are low).
Note: If your participation is 100 hours or less, you cannot use this test.
What Doesn't Count (Specific Examples):
Reading Books and Education: Generally, time spent reading real estate books, attending seminars, or taking courses to learn about real estate investing does not count towards the 750 hours or material participation. This is considered education for future activities, not current operational involvement. However, some sources suggest that attendance at industry-specific workshops or seminars to stay updated on trends or legal changes might be considered by some tax professionals as counting if it's directly relevant to the operation or management of your existing real estate businesses, but this is a gray area and should be approached with caution and strong documentation.
Researching New Investments: Hours spent Browse Zillow, analyzing potential new properties to buy, or looking into market trends for future investments are generally considered investor activities and do not count towards your REPS hours. The work must be tied to a current real property trade or business in which you have an interest and materially participate.
Commuting Time: Time spent traveling to and from properties is usually considered commuting and does not count. However, if you have a bona fide home office and your travel is between that home office and your properties for direct business activity, some tax court cases have allowed it, but this is a highly scrutinized area.
Investor Activities: Studying financial statements, preparing personal summaries of finances, or monitoring operations in a non-managerial capacity for properties you've invested in. If you're not involved in the day-to-day operations, these hours are usually excluded.
Work Done to Avoid Disallowance of Losses: Any work primarily performed to meet the REPS requirements rather than for genuine business purposes will likely be disqualified by the IRS.
On-Call Hours: Simply being available by phone for emergencies or issues with a property generally does not count. You must actually perform services.
Work as an Employee (unless significant ownership): If you work for a real estate company as a W-2 employee, those hours typically do not count unless you own 5% or more of that company.
Crucial Advice:
Meticulous Record Keeping: The IRS heavily scrutinizes REPS claims. You must keep detailed, contemporaneous records. This means logging dates, times, specific tasks performed, and the property or activity to which the hours relate. Appointment books, calendars, and narrative summaries are considered reasonable means of proof.
