Employees in Real Property Trades or Businesses – Do They Qualify as Real Estate Professionals?
The answer is YES and NO. It depends!
The benefits:
A real estate professional as defined in Internal Revenue Code Section 469(c)(7) and Regulation Section 1.469-9 receives significant tax benefits. A taxpayer may not be subject to certain taxes on income earned from the rental of real estate by being classified as a real estate professional. In addition, a real estate professional may be able to currently deduct losses incurred from the rental of real estate without regard to the passive loss limitations.
Generally, income arising from rental of real estate is excluded from the definition of self-employment income for the purpose of the self-employment tax. Additionally, the tax on net investment income does not apply to rental income earned by a real estate professional.
For tax years beginning in 2013 and later, a 3.8% tax is imposed on the net investment income of taxpayers whose modified adjusted gross income (MAGI) exceeds certain statutory amounts. A married couple who files a joint income tax return and whose MAGI is greater than $250,000, and a married individual filing separately whose MAGI is greater than $125,000, will be subject to this tax if they have net investment income. In all other cases, individuals with MAGI greater than $200,000 will be subject to the tax on their net investment income.
The requirements:
A taxpayer will be considered a real estate professional if (1) more than one-half of the total personal services the taxpayer performs in trades or businesses are performed in real property trades or businesses in which the taxpayer materially participates and (2) the taxpayer performs more than 750 hours of services during the tax year in real property trades or businesses in which the taxpayer materially participates. Although the Code does not refer to individuals meeting this test as real estate professionals, various IRS regulations and publications and the Tax Court refer to taxpayers in real property businesses who meet the stipulated statutory requirements as real estate professionals.
Real property trade/business is further defined as real property development, construction, acquisition, conversion, rental operation, management, leasing or brokerage.
The application:
It is very common that an employee who works for a real estate brokerage firm or a real estate management firm also owns and operates rental properties. While they are spending significant time in a real estate trade or business, the hours spent as an employee will not count toward the “more than one-half of the total personal services” and the 750 hours requirements. Hours spent as an employee only will count toward this test if the employee owns more than 5% of the employer.
Angela Tsui
212-751-9100
[email protected]
To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.
