As the real estate market continues to evolve, we want to ensure you’re informed about important tax court decisions that may impact your investment strategy and tax planning. In this newsletter, we’re focusing on a recent Tax Court case that provides critical clarification on the requirements for qualifying as a “real estate professional” for tax purposes.
Why This Matters to You
Real estate professional status allows taxpayers to deduct rental real estate losses against other income without limitation by the passive activity loss rules. Without this status, rental losses can typically only offset passive income or be carried forward until property disposition.
Recent Case Highlight: Warren v. Commissioner
In the recent Tax Court case Warren v. Commissioner (T.C. Summary Opinion 2024-20), the court provided important guidance on meeting the stringent requirements for real estate professional status.
The taxpayer in this case attempted to claim real estate professional status to deduct rental property losses against other income. However, the court ruled against the taxpayer because they failed to adequately substantiate the time spent on real estate activities.
Key Requirements Reinforced
The case emphasizes two primary requirements for qualifying as a real estate professional:
- Material Participation Threshold: More than 50% of your personal services performed during the tax year must be in real property trades or businesses in which you materially participate.
- Hours Requirement: You must perform more than 750 hours of service during the tax year in real property trades or businesses in which you materially participate.
Critical Lessons, Planning Opportunities & Strategic Considerations
In light of the Warren decision, we recommend the following proactive steps:
- Implement Robust Documentation Systems:
- Maintain detailed daily logs of all real estate activities
- Record specific properties involved, nature of activities performed, and exact time spent
- Take photos or retain receipts that corroborate your physical presence and work performed
- Consider using specialized real estate activity tracking applications
- Strategic Time Allocation:
- If you’re close to meeting the thresholds, consider restructuring your professional activities to ensure you exceed both the 750-hour requirement and the 50% threshold
- Group similar activities when efficient, but document each property separately
- Remember that time spent on investment activities (like analyzing potential purchases) generally doesn’t count toward the hourly requirements
- Entity Structure Review:
- Evaluate whether your current business structure optimizes your ability to qualify as a real estate professional
- Consider if grouping elections under Treasury Regulation 1.469-9(g) would benefit your specific situation
- Assess whether your spouse’s participation could help meet the requirements
Next Steps: Proactive Tax Planning
Please contact your HDGP professional if you have any questions about your current real estate position or would like to discuss further. We’ll review your real estate activities and documentation in light of the Warren decision and identify opportunities to strengthen your position while maximizing available tax benefits.