Criteria for Claiming Nonpassive Treatment Related to Rental Real Estate
Table of Contents
- Introduction
- Real Estate Professional Status
- Material Participation Tests
- Benefits of Nonpassive Treatment
- Example
- Resources
- Conclusion
Introduction
To claim nonpassive treatment for rental real estate, a taxpayer must meet specific criteria set by the IRS. These criteria focus on the taxpayer’s level of participation in the real estate activity. This guide outlines the primary requirements and benefits of achieving nonpassive treatment for rental real estate.
Real Estate Professional Status
To be considered a real estate professional, and therefore potentially qualify for nonpassive treatment, a taxpayer must meet the following tests:
Material Participation Test
The taxpayer must materially participate in the rental real estate activity. This means they must be involved in the operations of the activity on a regular, continuous, and substantial basis.
750-Hour Test
The taxpayer must spend more than 750 hours during the tax year in real property trades or businesses in which they materially participate.
More Than Half of Personal Services Test
More than half of the personal services the taxpayer performs in all trades or businesses during the tax year must be in real property trades or businesses in which they materially participate.
Material Participation Tests
If a taxpayer does not qualify as a real estate professional, they can still achieve nonpassive treatment by meeting one of the seven material participation tests for each rental activity:
500-Hour Test
The taxpayer participates in the activity for more than 500 hours during the tax year.
Substantially All Participation Test
The taxpayer’s participation in the activity constitutes substantially all of the participation in the activity of all individuals (including non-owners) for the year.
100-Hour Test
The taxpayer participates in the activity for more than 100 hours during the tax year, and no other individual participates more than the taxpayer.
Significant Participation Activity Test
The activity is a significant participation activity (SPA), and the taxpayer’s total participation in all SPAs exceeds 500 hours.
Material Participation in Five of Ten Years Test
The taxpayer materially participated in the activity for any five tax years (whether or not consecutive) during the ten tax years immediately preceding the current tax year.
Personal Service Activity Test
The taxpayer materially participated in a personal service activity for any three tax years (whether or not consecutive) preceding the current tax year.
Facts and Circumstances Test
Based on all the facts and circumstances, the taxpayer participates in the activity on a regular, continuous, and substantial basis during the year. (Note: This test generally requires more than 100 hours of participation.)
Benefits of Nonpassive Treatment
- Deductibility of Losses: Losses from nonpassive rental real estate activities can offset other types of income, such as wages or investment income.
- Active Participation: Taxpayers who actively participate but do not qualify as real estate professionals may still deduct up to $25,000 of rental real estate losses against nonpassive income, subject to a phase-out for higher income levels.
Example
John, a full-time real estate agent, spends 1,200 hours a year managing his rental properties. He spends more than 750 hours and more than half of his personal service time on real estate activities. John qualifies as a real estate professional and his rental activities are considered nonpassive.
Resources
For more details on nonpassive treatment for rental real estate, refer to IRS Publication 925: Passive Activity and At-Risk Rules.
Conclusion
By meeting the criteria outlined above, taxpayers can ensure their rental real estate activities are treated as nonpassive, allowing for more favorable tax treatment. Consulting with a tax professional can provide further guidance and ensure compliance with IRS regulations.