Real Estate Professional Status (REPS) is a powerful tax tool that helps significantly reduce your tax exposure. To gain the status, you must be actively involved in the real estate business and qualify as a real estate professional. Once you obtain the REPS designation the IRS permits the deduction of real estate losses from your other income which reduces your total taxable income. Let's understand how you can employ this designation to maximize tax savings.
REPS Explained
REPS is a designation created by the IRS for taxation purposes. It allows real estate professionals to set off their real estate losses against incomes from other sources. Such an allowance is not given to professionals in other fields. This designation is of great significance to real estate managers, developers, and operators. The overriding condition is that a person should spend a major amount of his/her time in the real estate business to avail of this deduction.
This law is aimed at encouraging certain real estate activities. REPS significantly influences how income and losses are reported in an individual's tax returns. It permits flexibility in financial and taxation strategizing and can have a major impact on the financial stability of your real estate business.
Qualification Requirements
To qualify for the REPS designation, you must fulfill the following conditions:
- Spend more than 750 hours of service every year in real property trades or businesses,
- Dedicate over half your working hours to real property trades or business services, and
- You must materially participate in every real estate activity
All three conditions must be fulfilled for you to be designated as REPS.
Under IRC Sec. 469(c)(7), real property trade or business includes construction, reconstruction, development, redevelopment, acquisition, management, rental, operation, leasing, or brokerage trade or business.
Tax Benefits
You can avail of significant tax benefits if you are a real estate professional. These include:
- Preventing the application of passive activity loss (PAL) limitation rules, and
- Rental income is exempted from the 3.8% net investment income (NIIT) tax.
Passive Activity Loss (PAL) Rules
Generally, taxpayers considered to be real estate professionals under the law are engaged in the business of renting out owned properties throughout the year. The IRC presumes rental activities and any income received from such activities to be passive. Sec 469 limits the taxpayer's ability to set off passive activity loss (PAL) against income from non-passive sources. PAL is only deductible from passive activity income, with the rest of the loss being carried forward. However, on being designated REPS, a real estate professional is not subject to these PAL limitations and can set off rental losses against other incomes from non-passive sources.
Net Investment Income Tax (NIIT) Rules
These rules apply to any income derived from investments and include royalties, rent, dividends, or interest. These rules will not apply to a real estate professional provided he/she:
- Qualifies for REPS designation,
- Receives rental income in the ordinary course of business, and
- The rental activity is not regarded as a passive activity under Sec. 469.
Gaining the REPS designation is strategically beneficial if you have major investments and involvement in the real estate business. It gives you the opportunity to leverage tax benefits to promote business growth and development.
FinloTax: A Reliable Tax Consultancy Firm in CA
We are FinloTax, a professional taxation firm based in CA. Our affordably priced services include bookkeeping, tax prep, tax planning, payroll, and compliance solutions. We can help optimize your real estate investments to reduce your tax liability. If you wish to apply for REPS or want to know details, get in touch with our experts at 408-822-9406.