What Is Real Estate Professional Status (REPS) And How You Can Benefit From It

Real estate investing is a popular way to diversify investments, generate passive income, and gain appreciation on capital investments. For high-income earning families, however, real estate investment can also provide a significant tax benefit. As income increases, tax deductions phase out, leaving high-income earners with an ever-increasing tax bill. Real estate professional status (REPS) can offer a way to reduce tax liability for high-income families.

REPS is a status granted to individuals who spend more than 750 hours per year managing their own or other people’s real estate properties. REPS allows individuals to treat rental real estate as a business rather than a passive investment, enabling them to take deductions against other sources of income. These deductions can include mortgage interest, property taxes, repairs, and depreciation.

For families with high-income earners, REPS can provide a significant tax advantage. In most cases, the spouse with the lower income is designated as the real estate professional, enabling them to take advantage of the tax benefits associated with REPS. The high-income earner can continue to focus on their career while the spouse manages the family’s real estate investments full-time.

Large companies increasingly employ high-profile positions, such as physicians, engineers, and attorneys. As a result, many high-income earners have become W2 employees, reducing the deductions available to them. REPS provides a way to mitigate the loss of these deductions by treating rental real estate as a business.

In conclusion, REPS is a valuable tool for high-income families looking to reduce their tax liability. By designating one spouse as the real estate professional and managing rental properties as a business, families can take advantage of deductions and reduce their overall tax burden.

About Real Estate Professional Status

To qualify for real estate professional status (REPS), you need to have performed more than half of your personal services in real property trades or businesses and materially participated in them for over 750 hours during the tax year. Essentially, your primary job needs to be in the real estate industry. It is not necessary to have any degree, certification, or license to qualify as REPS, and only one spouse needs to meet the requirements for a married couple.

REPS designation provides an opportunity for high-income couples to divide and conquer responsibilities. One spouse can focus on their high-income profession while the other manages all the day-to-day activities of real estate investments as REPS. By doing so, the couple can qualify for significant tax benefits.

IRS Publication 925 contains detailed guidelines for claiming REPS. Typically, the 750-hour requirement leaves little time for other part-time jobs. Therefore, it is essential to have real estate as your primary job to qualify for REPS.

Tax Advantages Of REPS, Plus An Example

Real estate investments often create paper losses for investors through cost segregation studies, accelerated depreciation, and other means, resulting in reduced tax liability. However, high-income couples earning over $150,000 cannot use passive real estate losses to reduce their taxable income since there are no special allowances from the IRS. These passive losses carry forward until a year of passive gains from real estate investments occurs since they cannot offset active income such as W2 income, unless one spouse qualifies as a real estate professional.

Consider Samantha and her family as an example. Samantha’s husband is an executive at a well-known entertainment company, while she manages their household, raises their child, and oversees the family’s investment strategy. Samantha has designated herself as a real estate professional, and her full-time job is managing the day-to-day activities of their real estate investments. Although their properties generate cash flow, Samantha’s real estate business created $150,000 in losses, which is where it gets interesting.

If Samantha has met the qualifications for real estate professional status, the couple can deduct the full $150,000 in losses from Barrett’s $250,000 active income, resulting in a taxable income of only $100,000 and lowering them to a lower tax bracket.

On the other hand, if Samantha doesn’t qualify or doesn’t designate as a REPS, they will be taxed on the full $250,000 of income, essentially doubling their tax bill.

Without REPS designation, Samantha’s $150,000 passive losses would have to be carried forward until they generate passive gains against which they can apply them. Meanwhile, the couple will be taxed on Barrett’s entire income for several years.

Why pay more taxes than necessary, especially if tax savings can be invested in your next investment opportunity to help achieve your financial goals faster?

How To Achieve REPS

To implement the strategy of designating one spouse as a real estate professional, you first need to choose which spouse will assume this role. If one spouse is already the primary breadwinner, the decision is typically straightforward. However, for families where both spouses work, the decision may be more challenging and require considering each spouse’s income, career trajectory, passion for real estate, and ability to manage the responsibilities of the role.

Whichever spouse assumes the role of real estate professional must treat it as a serious business and dedicate themselves to managing the investments carefully. It’s also recommended to consult with a CPA to ensure proper timing, designation, and coordination with other tax strategies.

Once the decision is made, set aside funds for investments, start shopping for properties, and establish business-like systems to manage real estate investments separately from personal activities. This includes using separate bank accounts, accounting programs, email addresses, and other tools to ensure clarity and separation between personal and investment activities.

Making REPS Benefit Your Family

Real estate investments and achieving REPS status may look different for every family. Let’s examine two scenarios for clarity. In the first scenario, one spouse is working full-time and leaning into their high-income earning profession, while the other works part-time while materially participating in managing the couple’s real estate investments. In the second scenario, one spouse is working, while the other, who is a homemaker, decides to make managing real estate investments their primary job.

Regardless of the scenario, the spouse managing real estate needs to commit to their material participation in the day-to-day decisions regarding their real estate properties. They should accumulate 750 hours or more of tracked time and activities over the taxable year. It would be challenging to spend 750 hours on just a few properties. Thus, if you accumulate several properties quickly, track your time and business activities managing them, and treat your investment properties as a business, you’re more likely to achieve all the qualifications for REPS.

Treating investments like a business means having formalities and systems in place, deciding when to raise rents, renew leases, buy, sell, renovate, and more. By constantly approaching your day intending to maximize profit while simultaneously improving your tenants’ experience, tracking your time and activities, and coordinating with contractors toward successful renovations, you’re on your way!

Usually, the 750-hour requirement is per real estate property. Still, you can combine all of your real estate management activities from several properties into one by including the following language in your tax returns. Under IRC Regulation 1.469-9(g)(3), the taxpayer hereby states that they are a qualifying real estate professional under Code Sec. 469(c)(7) and elect under Code Sec. 469(c)(7)(A) to treat all interests in rental real estate as a single rental real estate activity. That phrase “taxpayer hereby states that they are a qualifying real estate professional” is critical.

Each family is entitled to their own beliefs and opinions about which spouse should work and about the division of labor and responsibilities between the two spouses. However, if one spouse can hit these requirements, coordinate with tax professionals, and find joy in managing real estate investment assets for the family, REPS can be a huge advantage! To achieve this, you need to decide which spouse will become the real estate professional. For some families, this is easy because one spouse is already the primary breadwinner and the other is a homemaker.

For other families where both spouses are working, the choice may be a little more challenging. Beyond each spouse’s current income, consider things like career trajectory, passion for career, passion for real estate, other assumed roles as the real estate professional, and each spouse’s ability to self-propel organizational and management activities. It’s important to discuss this with your CPA so that you can coordinate timing, real estate purchases, designations, and more. From there, set aside funds to invest, start shopping for your first several investment properties, and track your real estate business activities closely. Use separate bank accounts, an accounting program, a separate email address, and other business-like systems with your real estate investments to further separate and clarify investment management activities from any personal activities.

Is Real Estate Professional Status For You Or Your Spouse? 

Married couples with an income exceeding $150,000 may be frustrated with their high tax liability and have turned to real estate to reap the tax benefits. However, to apply on-paper losses to active income, obtaining real estate professional status is crucial; otherwise, passive losses will need to be carried forward for years.

It is essential to note that this article does not provide tax or life advice. Instead, use this as a starting point for further research, discussion with your spouse, and reflection on how to reach your investment and lifestyle objectives more efficiently.