By Jason Watson, CPA
Posted Sunday, March 22, 2026

If you meet the 750-hour requirement and more than half of your personal services are performed in real property trades or businesses, you qualify as a real estate professional. However, and as a reminder, to have your rental activities be considered nonpassive (so your rental losses are nonpassive), you must materially participate in your rentals. Yes, this is nuanced.

For example, many licensed real estate agents can easily satisfy the REPS hours test for being a real estate professional. However, they might not spend enough time on their own personal rental properties or rental activities, and therefore cannot prove material participation (MP hours).

Material Participation Trap

As we’ve mentioned a whole bunch, do not confuse your 750-hour REPS eligibility test with the material participation test for a specific rental property. Time spent acquiring a property can generally counts toward your overall 750-hour REPS threshold, but it does not count toward the hours needed for material participation on that specific property until it is placed in service.

There is, however, a critical material participation exception for real estate investors who are expanding an existing rental portfolio. If you make the formal election under Treasury Regulation Section 1.469-9(g) to treat all your rental real estate interests as a single activity, the landscape changes in your favor.

Why? Courts often view acquisition work as preliminary investment activity rather than participation in an existing rental activity unless the taxpayer has grouped their rental properties into a single ongoing activity.

Because the aggregated single activity is already a going concern, the time spent shopping for and acquiring a new property is viewed as expanding an existing business rather than starting a new one from scratch. In this grouped scenario, your acquisition hours may count toward material participation in the grouped activity and also count toward your 750-hour REPS requirement.

Spouse Hours For Material Participation

Spouses cannot combine hours to satisfy the 750-hour real estate professional test. Got it.

However, both spouses can contribute to the material participation requirement. Your spouse could be the 750 big shot and throw a hammer from time to time on your gaggle of rental properties. You can splash some paint on the walls as well. Both the hammer and the paint count for material participation for your spouse’s ability to materially participate in the rental activities.

Regulations 1.469-9(g) Election for REPS

We discussed this in a previous section when reviewing material participation. Here is a brief summary again-

You can elect to treat all your rental real estate interests as a single activity so that material participation is measured across the entire portfolio. If you had three separate rentals and relied on the 500-hour material participation test, you would need to satisfy that test for each property individually. That’s 1,500 hours total at a minimum.

The Treasury Regulations Section 1.469-9(g) election is a formal election on the tax return that endures each year unless revoked.

Sidebar: There is another sliver of business activity where the average guest stay is 30 days or less and you provide significant personal services such as daily linen changes, concierge services, bed and breakfast arrangements, etc. We won’t muddy the waters with that here, but it’s worth noting that the 7-day rule isn’t the only exception to the grouping party.

However, and this is a big deal, you generally cannot group short-term rentals with average guest stays of 7 days or less with traditional rental real estate activities (such as your mid-term and long-term rentals). Wait, what? Short-term rentals, as defined just now, are not considered rental activities under Treasury Regulations §1.469-1T(e)(3)(ii). In other words, you cannot mix apples and oranges with this grouping election. Group short-term rentals for STR loophole, and group other rentals for REPS.

Are there other downsides to the election? Yes there are. Again, please check out the section above. There is a ton more to it than what we listed here.

Material Participation Time Examples

See our material participation time examples section or a list of tasks and efforts spent on your rental property that count for REPS material participation.

By Jason Watson, CPA
Posted Sunday, March 22, 2026

Short-term rentals with average guest stays of 7 days or less create an odd technical problem for the 750-hour test because the regulations state they are not considered rental activities. Wait, what? It’s true! But there is an escape hatch at the end. Stay with us for a bit.

Treasury Regulations Section 1.469-1T(e)(3) reads “an activity involving the use of tangible property is not a rental activity for a taxable year if for such taxable year the average period of customer use for such property is seven days or less.”

Sidebar: Don’t confuse tangible property with personal property. Real property is tangible property since you can touch it, paint it, etc. Technically, tangible property has physical substance.

Read those last two sentences again. Are we telling you that a short-term rental with an average guest stay of 7 days or less is not considered a rental activity? Not even a real property trade or business for purposes of the passive activity rules? No, but the regulations are.

Oh, and so are the courts.

In Bailey v. Commissioner, Tax Court Memo. 2001-296, and again in Bailey v. Commissioner, Tax Court Summary Opinion 2011-22, which are different people with different facts but the same problem- the court used a literal interpretation of “the average period of customer use for such property is seven days or less” and stated that the activity was not a rental activity, and therefore the taxpayers could not rely on those hours to establish material participation.

The reasoning in both Tax Court decisions has been criticized because the analysis relied heavily on the formal election under Treasury Regulations Section 1.469-9(g) to group all rental activities into one activity for the primary purpose of demonstrating material participation. However, grouping activities for the 750 hours test does not rely on the formal election to group rental activities. We are getting a bit into the weeds.

The bad news is that courts have sometimes refused to count hours from short-term rentals with average stays of 7 days or less toward the 750-hour requirement. The good news is that these short-term rentals are typically not treated as rental activities and sidestep passive loss limitations. However, if you have a mixed bag of real estate investments, this potentially flawed Tax Court logic could become problematic.

Sidebar: Keep this 7 days or less thing in mind. Also, keep in mind that rental properties are presumed to be passive. The foundation of the short-term rental ‘loophole’ is that the activity is not classified as a rental activity because of the 7 days or less average guest stay. More on that in our short-term rentals section.

If you cannot get enough, here is a contradicting blurb from Chief Counsel Advice 201427016–

whether a taxpayer is a qualifying taxpayer within the meaning of section 469(c)(7)(B) and Treas. Reg. § 1.469-9(b)(6) depends upon the rules for determining a taxpayer’s real property trades or businesses under Treas. Reg. § 1.469-9(d), and is not affected by an election under Treas. Reg. § 1.469-9(g). Instead, the election under Treas. Reg. § 1.469-9(g) is relevant only after the determination of whether the taxpayer is a qualifying taxpayer.

Let’s break this down. IRC Section 469(c)(7)(B) refers to the 750 hours requirement. The Treasury Regulations 1.469-9(g) refer to the formal election to group all your rental activities together as a single activity for material participation testing. The Chief Counsel Advice suggests a different analytical approach than the one used in the Bailey decisions. Nice!

In other words, the IRS clarified their version of chicken and egg sequencing problem. The formal election under Treasury Regulations 1.469-9(g) to group rental activities together is typically considered after qualifying as a real estate professional. If you cannot or choose not to elect your rental properties under the 1.469-9(g) regulations, it should not be used as a wedge to unravel your grouping of all real property trade or businesses for the sake of the 750 hours test.

Tilt!

Could you make a reasonable argument that you are relying on Chief Counsel Advice 201427016? Perhaps, but this area remains unsettled.

How about this angle?

Treasury Regulations Section 1.469-1T(e)(3) merely states that short-term rentals with an average guest stay of 7 days or less are not considered rental activities. Got it. Beat up. Can’t forget. Like ever.

However, IRC Section 469(c)(7)(C) defines a real property trade or business much more broadly to include development, construction, acquisition, operation, management, leasing, and brokerage. Focus on operation and management for a minute.

In other words, an activity can fail the definition of a rental activity and still potentially qualify as a real property trade or business. As such, some practitioners, and WCG CPAs & Advisors tends to agree, argue that time spent operating or managing a short-term rental could still count toward the 750-hour requirement, even though the activity itself is not treated as a rental activity.

Essentially, the accounting industry, courts, and the IRS at times treat real estate professional status as if it applies only to rental real estate, when the statute actually refers more broadly to real property trades or businesses. A hotel is not rental real estate, we can all agree. However, a hotel is certainly a trade or business using real property.

Finding cracks and splitting hairs.

By Jason Watson, CPA
Posted Sunday, March 22, 2026

Let’s try to clear up some confusion on hours. There are two sets of hours. There are the hours that make up the 750 hours test to be called a real estate professional. We’ll call those REPS hours.

The other set of hours is material participation hours. We’ll call those MP hours.

• Can MP hours be considered REPS hours? Generally, Yes, they are a subset of REPS. Caution– see our REPS pitfalls with short-term rentals section.
• Can REPS hours be considered MP hours? They might, however, the list of activities that count towards REPS is much larger and includes real estate development, home building, real estate agent activities, among others.
• Can the same hour be used for both REPS and MP hours? Yes, provided the hour qualifies for both.

Think of REPS hours as determining whether you qualify as a real estate professional at all, while material participation determines whether losses from a specific rental activity are treated as non-passive.

Cool, so, what hours count?

Combining Real Estate Activities for 750 Hours Test

You may count hours from all of your real property trades or businesses toward the 750-hour test. Please do not confuse this with the formal election to treat all your rental properties as a single activity to satisfy one of the seven material participation tests. These groupings are very much different.

For the 750-hour test, there is no formal, irrevocable election required to “group” your time. The tax code effectively treats these hours as a giant bucket. As long as the work is performed in a qualifying real property trade or business and you materially participate in that activity, the hours count toward the 750-hour threshold.

You could have multiple sources of qualified material participation hours from time spent on your rental properties directly, to time spent as a real estate broker, to time spent as a home remodeler. Specifically, you spend 98 hours on your sole rental property, 120 hours as a real estate broker, and you also spend 550 hours remodeling homes. This is a total of 768 hours. No special election is required to count those hours together. With reference to our recently stated basics, you are now over the first of three hurdles to leverage the real estate professional status.

But wait! What about time spent on your short-term rental? We’ll get to that in a bit, and the answer isn’t one you are going to like.

Grouping Election For Acquisition Hours

If you make the formal election under Treasury Regulation Section 1.469-9(g) to treat all your rental real estate interests as a single activity, that helps material participation (which we talk about later). However, it is not required to use this grouping election for your 750 hours as we alluded to above.

Spouse Hours For The 750

Spouses cannot combine hours to satisfy the 750-hour test. Both spouses may qualify, but if things are tight, it is ideal to pick one person to focus their time on achieving the necessary amount of time.

Mortgage Broker, Tangential Real Estate Services

You do not have to be a licensed real estate agent or broker to be considered participating in a brokerage trade or business. However, mortgage brokerage activities are generally not considered a real property trade or business for purposes of IRC Section 469(c)(7). Chief Counsel Advice 201504010 states-

Webster’s Dictionary defines “real estate” as “property consisting of buildings and land; the business of selling land and buildings,” and defines “brokerage” as “the business of a broker” or the “broker’s fee or commission.”1 Webster’s defines a “broker” as “a person who helps other people… to buy and sell property.”2 Accordingly, the common and ordinary construction of “real property brokerage” for purposes of § 469(c)(7)(C) involves bringing together buyers and sellers of real property. This definition of “real property brokerage” does not include the brokerage of financial instruments.

Therefore the “financing” of real property such as by bringing together lenders and borrowers is not a real property brokerage trade or business within the meaning of §469(c)(7)(C).

Webster? Really?!

Being a Licensed Real Estate Agent

Since obtaining a real estate license is generally straightforward with relatively low barriers to entry, WCG CPAs & Advisors recommends being licensed for two reasons. It buttresses your overall 750 hours argument, and you might have access to additional resources to help you with real estate investment (and you might save a few bucks on commissions too).

Sidebar: 750 hours is not an easy target to hit for the casual real estate investor. It is basically 2 solid days a week, every week. Being a licensed agent provided more opportunities to safely and legally build REPS hours.

Interestingly, in Agarwal v. Commissioner, Tax Court Summary 2009-29, the IRS attempted to argue that an agent was not a licensed “broker” and thus could not be involved in a brokerage trade. Come on, IRS?! The Tax Court also relied on the Webster definition of the term “brokerage” and found in favor of the real estate agent.

Hours Worked as an Employee (The 5% Rule)

Let’s review IRC Section 469(c)(7) again since it’s been a few pages and likely a cocktail ago-

For purposes of this paragraph, the term “real property trade or business” means any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.

Here is an interesting and perhaps quirky development for the next cocktail: Hours spent as an employee do not count toward your REPS threshold unless the employee is a 5% or greater owner in the entity conducting the real property trade or business, per IRC Section 469(c)(7)(D)(ii) and Treasury Regulations Section 1.469-9(c)(5). For example, if you are a receptionist for a real estate developer and own no equity in the company, those hours generally cannot be used toward the 750-hour requirement.

In Calvanico v. Commissioner, Tax Court Summary Opinion 2015-64, and Pungot v. Commissioner, Tax Court Memo 2000-60, the taxpayers were denied real estate professional status because they did not own the required 5% of their respective employers, and consequently, the hours spent in their real property trades or businesses did not count toward material participation.

Sidebar: Specifically, in Calvanico, the court held that a real estate appraiser who worked for a public accounting firm was in a real property trade or business. However, the accountants and support staff were not considered working in real estate.

The Calvanico Tax Court case has some mini lessons:

• If you work for a non-real estate business doing real estate things, that time unlikely counts (Calvanico case).
• If you work for a real estate business doing non-real estate things, that time is unlikely to count.
• If you own 5% or more of a real estate business and your participation is material, the things you do are generally presumed to be real estate things and that time will count towards your 750 hours.

Who wants some gray water? Better than brown water, right? Yeah, we had to go there.

S Corp Consultancy Angle, Mechanics and Risks

Can you avoid the employee limitation by forming your own S corporation and consulting for a real estate firm instead of working as an employee? Theoretically, Yes. Theory and reality rarely occupy the same space, but let’s give it a whirl.

In this arrangement, you aren’t an employee of the real estate firm; you are an independent contractor providing management services. Since you own 100% of your S Corp, every hour spent on that real estate trade or business drops right into your 750-hour REPS bucket. Cautious Yay.

For this structure to hold water, the relationship must be a true B2B (business-to-business) engagement. Your S Corp should have a formal service contract, invoice the real estate firm for services, and ideally, provide similar services to other clients to demonstrate true independence. The last one is tough since many consultants have singular clients.

The IRS hates form over substance. Like a lot. If you were a W-2 big shot on Friday and became a 1099 consultant on Monday (doing the exact same job, at the same desk, with the same laptop) the IRS will likely reclassify you as an employee. If they successfully argue that your S Corp is merely a disguised employment shell or a tax vehicle, those consulting hours are likely disqualified for REPS because you don’t own 5% of the entity actually conducting the business (your supposed client).

Moreover, there is a possible counterargument to the S corporation consulting strategy. Even if the contractor relationship itself is respected, the IRS could argue that you aren’t actually in a real property trade or business, but rather a professional services trade or business that just happens to have a real estate client.

For example, accounting consulting, marketing consulting, or HR consulting for a real estate firm might be viewed as professional services rather than participation in the real property trade or business itself.

On the other hand, consulting that directly involves property management, development oversight, leasing strategy, construction management, or brokerage activity is much easier to connect to the statutory definition. As always, the closer the work is to the actual operation or management of real property, the stronger the argument that the hours qualify.

If you choose this path, you must be prepared to prove that your S Corp is a distinct, independent enterprise with its own profit motive and operational autonomy, and genuine contractor relationship.

By Jason Watson, CPA
Posted Sunday, March 22, 2026

Passives activity losses can only be offset by passive activity income. Generally, material participation changes the color of money, and the activity is no longer passive. However, rental activities remain passive even if you materially participate. You must materially participate as a real estate professional. Read that again.

If you cannot leverage real estate professional status or the short-term rental loophole, there is an exception allowing $25,000 of passive activity losses created by rental losses to be deducted against other nonpassive income. But you must actively participate.

Active participation is a less stringent standard than material participation, but it requires at least 10% ownership. For example, you may be treated as actively participating if you make management decisions in a significant and bona fide sense. Management decisions that count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and similar decisions.

Sidebar: California does not conform to the IRS allowance for real estate professionals. You can read more about this in our state problems with your rental property section for more information.

By Jason Watson, CPA
Posted Sunday, March 22, 2026

Why designate yourself as a real estate professional? Aside from being something cool to tell the grandkids, let’s presume that you have a loss on your rental property or in aggregate on your gaggle of rental properties. It is common to have a tax loss on your rental activities although it cash flows, and the primary reason is depreciation. How does this tax loss affect your tax return?

As a reminder, IRC Section 469 defines a passive activity as any activity that involves a trade or business in which an individual taxpayer does not materially participate. Passive losses and material participation are trigger words to make any real estate investor twitch.

Rental income is typically considered passive, meaning that you are not directly earning the income as you would with a W-2 job or as a small business owner. Generally, passive losses may be deducted from passive income. For rental income there is an exception allowing you to deduct passive losses from nonpassive income such as wages and business income but there are limits (of course there are!). Passive loss limits for taxpayers max out at $25,000, and that number decreases as your gross income increases. Yuck!

Specifically, passive activity loss limits reduce $1 for every $2 over $100,000 modified adjusted gross income (MAGI) and by $150,000 the passive loss deduction is $0. Bummer. For a deep dive into passive activity loss limits including how to calculate MAGI, see our passive activity loss limits section.

Sidebar: While the $25,000 allowance is standard for single and married-filing-jointly taxpayers, the rules for Married Filing Separately (MFS) are punitive. If you file MFS and lived apart from your spouse for the entire year, your special allowance is slashed to $12,500. However, if you lived with your spouse at any point during the tax year and file MFS, your special allowance is $0.

Not all is lost, however. If your rental losses are capped or disallowed (unallowed is the official word) because of passive loss limits, the portion exceeding the passive loss limit is carried forward on Form 8582, aggregated for each year and may be deducted in the year of disposal (sale). They may also offset future net rental profits; you had losses, they were carried forward, you now have rental profits and the suspended losses can be used to offset. We call these PALs (passive activity losses). Sounds fun. Your PAL will come to assist when you have passive income.

Spoiler Alert: If you qualify for REPS on your rental properties, the prior losses carried over on Form 8582 remain stuck unless you sell or have net rental income (profit). You can’t roll up with your REPS membership card and expect yesterday’s dirty laundry to be clean (yeah, we probably took that too far).

There is another angle to all this, and this is the gist of this section- if you are a real estate professional who materially participates in rental activities, as defined by the IRS, and not your bartender, you can deduct 100% of your rental property losses (you are not capped by passive loss limits). This makes sense since your rental income is no longer passive if it is your livelihood or at least a large portion of your livelihood. In other words, the real estate professional status (REPS) is essentially telling the IRS and the world that your rental activities are not something you tend to from time to time but rather are approached with the mindset of a busy business owner.

But wait! There’s more. When the Net Investment Income Tax (NIIT) was introduced along with the Affordable Care Act, the real estate professional designation became an important tax planning tool all over again. Huh? If your modified adjusted gross income (MAGI) hits a certain amount, the NIIT is charged on all portfolio (interest, dividends, capital gains) and passive activity income (rentals). However, if you are a real estate professional your taxable rental income (profits) is no longer deemed passive and as such is not being taxed by the net investment income tax of 3.8%. $100,000 in rental profits multiplied by 3.8% for 20 years. That could be huge!

By Jason Watson, CPA
Posted Sunday, May 25, 2025

Here are some FAQs you might find helpful as a chapter summary to our riveting real estate professional status material-

What is Real Estate Professional Status (REPS)?
REPS is an IRS designation that allows qualifying individuals to treat rental activities as non-passive, unlocking the ability to deduct rental losses against other income including high W-2 income.

What are the two main requirements for REPS?
You must spend 750+ hours on real property trades or businesses annually. Those hours must exceed 50% of your total working hours. From there, you must materially participate in your rental property activities.

Can I count hours from a W-2 job toward REPS?
Only if that W-2 job is in a real property business (like construction, brokerage, or property development).

What qualifies as a real property trade or business?
Straight from the code- Development, redevelopment, construction, acquisition, conversion, rental, operation, management, leasing, or brokerage.

Does owning a rental property qualify me for REPS automatically?
No. Ownership alone isn’t enough—you must also meet the hourly and participation tests.

Can I group all my rentals to meet REPS requirements?
Yes, but you must file a 1.469-9(g) election to treat all rentals as one activity for material participation purposes.

What is the 1.469-9(g) election?
It’s a formal election filed with your tax return that lets you group rental activities to simplify material participation time hurdles.

Can I revoke the grouping election?
Only with IRS permission and a material change in circumstances. In other words, unlikely unless you sell most or all your rental properties.

Does my spouse’s time count toward the 750 hours?
No. REPS qualification is individual, though material participation hours can be combined with your spouse’s.

Can a stay-at-home parent qualify for REPS?
Yes, if they meet both the 750-hour and more-than-50% tests through real property activities. Common strategy!

What happens if I qualify for REPS but don’t materially participate?
Your rentals are still considered passive, and losses will be limited.

What activities count toward material participation hours?
Tenant communication, leasing, showings, maintenance oversight, bookkeeping, and property management.

What doesn’t count toward material participation hours?
Researching properties, education, investor-level analysis, or work done while the property is not in service. There are some devils in the details.

Does short-term rental time count toward REPS?
No, if the average guest stay is 7 days or fewer, the IRS considers it a non-real estate activity similar to a hotel, and it won’t count for REPS. Yeah, bummer, and most people are unaware.

Is real estate education time REPS-eligible?
No. Time spent in courses or self-study does not count toward REPS hours.

Can I claim REPS if I own through an LLC?
Yes, as long as you materially participate in the rental activities within the LLC.

What if I work a full-time job—can I still qualify?
It’s tough. Unless your full-time job is in real estate activities, such as working for a developer, you must spend more time in real estate than at your job (so, 2,081 hours in real estate activities plus your 2,080 hours at your job… gets tough).

Does flipping or wholesaling count toward REPS?
Yes. Flipping and wholesaling are considered real property trades or businesses.

Do REPS hours have to be evenly spread across properties?
No, but you must materially participate in each activity unless you aggregate them under 1.469-9(g).

What are some audit triggers for REPS?
Two biggies- W-2 or using property managers extensively (the IRS looks at management fees listed on your tax return as a proxy).

Can I amend a return to claim REPS?
Yes, but be cautious. Retroactive REPS claims are closely scrutinized and must be well-supported.

Can REPS help with state taxes?
Maybe. Some states (like California) don’t conform to federal REPS rules, so deductions may still be limited at the state level. Yuck.

Do I need REPS to deduct cost segregation losses?
Only if your rental is passive. STRs (average guest stay of 7 days or less, material participation) or REPS (750 hours, more than 50%, material participation) allow those deductions to become non-passive and immediately usable.

Is REPS a one-time status or renewed annually?
REPS is tested every year—you must meet the 750-hour and more-than-50% thresholds each tax year.

By Jason Watson, CPA
Posted Sunday, May 25, 2025

Here is a snapshot of some issues the Tax Court has dealt with-

Wallach, Tax Court Summary 2012-94

The taxpayer was a real estate agent who attempted to deduct several travel expenses including Hawaii and Lake Tahoe. He attempted to claim the travel was for investment purposes by researching additional real estate, but his recordkeeping was shoddy and was denied the deduction.

Trzeciak, Tax Court Memo 2012-83

Taxpayer claimed that time traveling to and from rental properties added to the 750-hour and material participation requirements. IRS agent and Appeals officer said No. But it appears from the court records that perhaps the IRS would entertain travel time had the taxpayer asserted a home office deduction for rental property activities. The Tax Court was dealing with a different issue and did not address this on point.

Truskowsky, Tax Court Summary 2003-130

Unless a taxpayer can prove day-to-day managerial involvement, then travel time between a taxpayer’s house and the rental activity is considering commuting and therefore does not qualify towards the hourly requirements for real estate professional and material participation. Commuting according to IRC Section 162 is not deductible. Sorry.

Leyh, Tax Court Summary Opinion 2015-27

Real estate investor had only 632.5 hours on her time log but explained during audit that she had failed to record the time spent traveling among her 12 rental properties. The IRS countered that her log was inclusive of travel time, but based on her testimony at trial, the Tax Court found that she had not included travel time in the time log and allowed her to restate the time log.

Lee, Tax Court Memo 2006-193

In terms of recordkeeping and proving hourly involvement, the Tax Court has acknowledged that “reasonable means” is interpreted broadly. Nevertheless, a post event “ballpark guesstimate” will not suffice. Leave it to the Tax Court to bust out some slang.

Pohoski, Tax Court Memo 1998-17

The court stated the second test of material participation was not satisfied when taxpayers failed “to put forth some indication of the actual time spent by” third-party non-owners such as property management companies.

Manalo, Tax Court Summary 2012-30

To push the taxpayers over the 100-hour hurdle, petitioners introduced at trial three revised logs, including a last-minute log purporting to be a reconstruction of the hours of services Mr. Manalo performed with respect to the rental activities. The estimates in these revised logs, however, were uncorroborated and unreliable. The revised logs were prepared at various instances over a two-year period after the conclusion of IRS agent’s examination and are, according to petitioners, based on emails and archived documents. Those emails and archived documents, however, were never introduced into evidence at trial. The Tax Court stated, “The rule is well established that the failure of a party to introduce evidence within his possession and which, if true, would be favorable to him, gives rise to the presumption that if produced it would be unfavorable.” Yuck!

Kutney, Tax Court Summary 2012-20

Taxpayer used hourly estimates that varied throughout trial. The Tax Court considered this a post event “ballpark guesstimate” and denied the real estate professional designation.

Moss, 135 Tax Court 365 (2010)

The rental property owner argued that he should be permitted to include hours spent “on call,” when a tenant could contact him if necessary. The court denied the tax position because the taxpayer was not actually performing services during those hours, the time could not be counted toward the 750-hour requirement.

Escalante, Tax Court Summary Opinion 2015-47

The rental property owner listed hundreds of hours for writing checks and reviewing mortgage statements. The Tax Court considered how long it would take them to write their own checks based on their own experience of daily life.

Lucero, Tax Court Memo 2020-136

Mr. Lucero’s log reported hours for tasks that appear excessive in relation to the task described, such as spending two hours shopping for coffee filters at Bed Bath & Beyond, and included time shopping both for the Sea Ranch property and for personal items, such as one hour shopping at Gualala Supermarket for 2 items for the Sea Ranch property (garbage bags and facial tissue) and more than 20 personal grocery items. We have found the credibility of a taxpayer’s records to be diminished when the number of hours reported appears excessive in relation to the task described.

Iovine, Tax Court Summary 2012-32

Taxpayer was a pilot who worked for American Airlines and worked 812 hours according to timesheets provided. The taxpayer was not able to prove that he spent more than 812 hours on his real estate activities. More importantly he failed to make the election to treat all rental properties as a single activity.

Miller, Tax Court Memo, 2011-219

The taxpayer was a boat pilot. Although he was employed full-time, he worked less than 1,000 hours as a boat pilot. His time logs were kept contemporaneously and appeared to be credible. Further, witnesses testified on the taxpayer’s behalf on the taxpayer’s incredible work ethic and bolstered his credibility. The Tax Court agreed.

Fitch, Tax Court Memo 2012-358

One spouse was a licensed real estate agent while the other spouse worked on the rental properties. The Tax Court found that they satisfied test #2 of the material participation tests since their participation in the rental real estate constituted substantially all of the participation. Mr. Fitch testified extensively as to the activities he performed with respect to his rental properties including advertising, bookkeeping, accounting, dealing with contractors, decorating, resolving fence disputes, making repairs, paying taxes, and procuring insurance. Occasionally hiring a contractor to perform technical tasks does not disqualify the substantial day-to-day management of the rental properties from constituting “substantially all of the participation”.

Chambers, Tax Court Summary 2012-9

Tax Court allows a limited partner in a partnership to count that time towards material participation. Generally limited partners on paper cannot by definition materially participate, however, the actions of the taxpayer actually suggested a general partner and not a limited partner. The taxpayer eventually lost on the 750-hour rule for real estate professional status.

Aren’t we all better criminals after watching Law & Order or American Justice Files? Kidding aside, use these tax court cases as a rubric of what not to do. There are a buttload or boatload depending on your geographical vernacular of other tax court cases.

By Jason Watson, CPA
Posted Sunday, May 25, 2025

Here are some common strategies for leveraging the real estate professional status (REPS). These are often combined.

• If you are married and one spouse has W-2 income, the other spouse who does not work (or even stays home with the ankle biters) becomes a great candidate for REPS.

• To piggyback the piggyback, this same non-W-2 spouse could be the general contractor on the next rental property rehab for your “buy rehab rent refinance repeat” (BRRRR) pleasure.

• To piggyback the piggyback, this same non-W-2 spouse could be the general contractor on the next rental property rehab for your buy rehab rent refinance repeat pleasure.

• Timing is a big deal too. You buy three rentals and perform cost segregation studies on them for that juicy depreciation deduction. The depreciation deduction is a singular shot and does not repeat. Perhaps your income is also unusually high that year as well. That might be the perfect time to blitz this REPS thing, take your tax deduction and then turn it all over to a property manager the following year. 100% legit.

Also, it is commonly forgotten that REPS also eliminates the net investment income tax (NIIT) since the rental income is no longer considered passive investment income. Most rental property owners think of real estate professional status as a tax deduction- while true, it also can remove the 3.8% tax on net aggregate rental profits.

By Jason Watson, CPA
Posted Sunday, May 25, 2025

Here is a list of questions and tests the IRS will blast through if your real estate professional status is challenged. We gleaned several items and took some liberties for emphasis and readability from the IRS Passive Activity Loss Audit Techniques Guide–

• Describe the work you perform as a real estate professional. Check occupations by signatures and W-2s.

• Who is the real estate professional, you or your spouse?

• Does the spouse claiming to be the real estate professional work full-time or part-time? How many hours specifically? Are they corroborated with pay stubs?

• Approximately how many hours did you spend working on your rentals in the year under exam? Ask the taxpayer for supporting documentation (appointment books, diaries, calendars, logs, etc.) You may want to give the taxpayer a time log to be completed for each rental – and for each year under exam. Material participation is a year-by-year determination. Rental property activities are generally not time intensive (so says the IRS).

• If the non-working spouse claims to be the real estate professional, ask what other commitments they might have. Is the spouse a student? Is the spouse providing full-time care to young children? Do you see them at soccer practice?

• Who monitors the rental properties? Who collects the rent? Who does the repairs? Who pays the bills and balances the checkbook?

• Do you have a real estate agent or property manager or employee responsible for any of the rentals? Ask for each rental property. Check Schedule E for large commissions or management fees. Also check for large labor expense since a hired contractor might have spent more time than taxpayer (see material participation test #3). If there is paid property management, it is a strong indicator taxpayer did not materially participate.

• Is anyone besides you involved with managing or overseeing any the properties? Does a relative or friend manage/monitor the property for free?

• Does a tenant receive free/reduced rent for managing the rentals – or for caring for the properties?

Indicators that the taxpayer did not materially participate:

• The taxpayer’s residence is hundreds of miles from the rental property. Are there personal reasons for the taxpayer to visit the rental property such as family or friends close by. Did the taxpayer ever live in the rental property and establish relationships nearby?

• The taxpayer has numerous other investments, rentals, business activities, or hobbies that absorb significant amounts of time.

• The taxpayer is elderly or has health issues.

• The majority of the hours claimed are for work that does not materially impact the rental property.

• Rental property operations would continue uninterrupted if the taxpayer did not perform the services claimed.

• 100 hours and more than anyone else: The taxpayer must not only prove they worked more than 100 hours, but more than anyone else. They must be ready to provide evidence of the participation of others. Additionally, there is no provision in IRC Section 469 to divide employee time by each unit.

• Substantially all: It will be very difficult for the taxpayer to meet this test for any condo-type activity that either has a management firm or is located away from the taxpayer’s residence with someone who manages the activity.

• Facts and circumstances: This test cannot be used if anyone besides the taxpayer is paid to manage the activity. An on-site management agency disqualifies the taxpayer from using this test.

• Request a copy of any management or commission agreement. Frequently, there is little left for the taxpayer to do.

• Significant time claimed for reading reports, paying bills or other investor-type hours, which are generally disregarded in the material participation tests.

The notes from the ATG are extremely helpful since it allows the rental property owner seeking real estate professional status to narrow down what the IRS is looking for. Knowing someone else’s argument or perspective ahead of time is essential for audit success.

By Jason Watson, CPA
Posted Sunday, May 25, 2025

Here are some pitfalls with real estate professional status-

• Having a management company generally kills off #2 and #3 of the material participation tests, leaving #1 which is the 500 hours threshold. 10 hours a week. Every week. That’s a whole day and then some.

• Having a W-2 job is not an instant killer. However, it becomes an audit risk. You will either need to prove that you spend more hours on real estate activities than your part-time W-2 gig or that you are a 5% or greater owner in a company that qualifies as a real estate trade or business.

• Having multiple rental properties and not aggregating through the Treasury Regulations 1.469-9(g) election (more on that later).

• Poor documentation and crappy corroboration. Or crappy documentation and poor corroboration. You might be considered to have disguised disorganization. The possibilities are endless.

See our REPS pitfall with short-term rentals section and REPS pitfall with material participation section.

Here is a summary of how W-2 jobs can be problematic or useful-

As listed in our mini agenda, we dug deep into the material participation list in a previous section on page xx. In that section we also provide excerpts from the IRS Passive Activity Loss Audit Techniques Guide (ATG) plus our own commentary. Here is the list again according to Temporary Treasury Regulations 1.1469-5T(a)–

(a) In general. Except as provided in paragraphs (e) and (h)(2) of this section, an individual shall be treated, for purposes of section 469 and the regulations thereunder, as materially participating in an activity for the taxable year if and only if—

(1) The individual participates in the activity for more than 500 hours during such year;

(2) The individual’s participation in the activity for the taxable year constitutes substantially all of the participation in such activity of all individuals (including individuals who are not owners of interests in the activity) for such year;

(3) The individual participates in the activity for more than 100 hours during the taxable year, and such individual’s participation in the activity for the taxable year is not less than the participation in the activity of any other individual (including individuals who are not owners of interests in the activity) for such year;

(4) The activity is a significant participation activity (within the meaning of paragraph (c) of this section) for the taxable year, and the individual’s aggregate participation in all significant participation activities during such year exceeds 500 hours;

(5) The individual materially participated in the activity (determined without regard to this paragraph (a)(5)) for any five taxable years (whether or not consecutive) during the ten taxable years that immediately precede the taxable year;

(6) The activity is a personal service activity (within the meaning of paragraph (d) of this section), and the individual materially participated in the activity for any three taxable years (whether or not consecutive) preceding the taxable year; or

(7) Based on all of the facts and circumstances (taking into account the rules in paragraph (b) of this section), the individual participates in the activity on a regular, continuous, and substantial basis during such year.

Tests #1, #2 and #3 are the ones used 99% of the time by real estate investors. You can read the IRS Audit Techniques Guide (ATG) for Passive Activity Losses with this link-

https://wcginc.com/wp-content/documents/ATG-PAL.pdf

By Jason Watson, CPA
Posted Sunday, May 25, 2025

Before we go too far down the REPS road, let’s quickly review the simplified basics of real estate professional status-

• You materially participate and provide personal service hours of 750 or more in real property trades or businesses, and

• Over half of your time spent on all activities where you perform a personal service must be spent on real property trades or businesses (this includes W-2 jobs and small businesses). If you work 2,080 hours as a 9-5er W-2 suit, you will need to work 2,081 hours in real estate. Sure, no one wears suits anymore, but you get it.

If you meet these two, you are what the IRC refers to as a qualifying taxpayer, or what the industry calls a real estate professional. But you are not done! The final step is to demonstrate material participation as a real estate professional in each of your rental activities unless formally elected to group all activities as one (more on the 1.469-9(g) election in a bit).

Could you be deemed a real estate professional by definition but not be able to deduct your rental losses? Yes, technically you could. Like a lame duck, you met the two hurdles above but did not materially participate in your rental property activities, so the whole exercise is worthless. This is more common than you think, and we will show some examples later.

As a reminder, IRC Section 469(c)(7) again for fun-

For purposes of this paragraph, the term “real property trade or business” means any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.

By Jason Watson, CPA
Posted Sunday, May 25, 2025

Chapter 8 is another tactical tax planning chapter for rental property owners. Last chapter was the short-term rental loophole, and we are turning the page like Bob Seger. The real estate professional status, codified under IRC Section 469(c)(7), can create the ability to deduct rental losses against W-2 wages, business income, and other nonpassive earnings. Similarly to the short-term rental loophole, REPS is one of the most powerful tax tools in real estate, but also one of the most misunderstood and scrutinized.

The chapter begins by explaining how real estate income is typically classified as passive and subject to loss limitations. If your modified adjusted gross income (MAGI) exceeds $150,000, you likely can’t deduct your rental losses unless you qualify for REPS. To do so, you must meet two key tests: 1) spend at least 750 hours on real property trades or businesses, and 2) over half of your personal service time must be in those trades. This chapter dives deep into what activities and hours count, and when short-term rental time is excluded.

But REPS tests above alone isn’t enough. You must also materially participate in your rental activities. The chapter includes real-world strategies, IRS audit triggers including a nice series of questions, and court case insights to help you avoid common pitfalls.