Real Tax Strategies for Real Estate

The main reason real estate can be an attractive tax-saving opportunity is because it often generates passive losses on paper.

These losses usually come from depreciation or large expenses (like renovations or repairs). By default, passive losses can’t offset active income from a job or business.

That is, unless you qualify for an exception.

The strategies listed below explain three of the most common ways to unlock passive losses and reduce your taxes.

For most taxpayers with modified adjusted income (MAGI) below $150,000, the IRS allows up to $25,000 of losses associated with real estate to offset your active income.

The requirements for using the passive loss allowance aren’t as rigorous as those for the STR loophole or REPS (more on these below), but the total benefit gradually phases out between MAGI of $100k-$150k.

This option can be a straightforward way to use passive losses, but only works in lower income years. Like the other strategies explained later, using this one still requires you to actively participate in each rental.

Another common way to offset active income with passive losses from real estate is to use the STR loophole. This works if each rental activity has short-term stays and you (or your spouse) materially participate in a given tax year.

The keywords here are short-term stays and material participation. The IRS expects you to prove your real estate activity qualifies for both.

Here’s how you do that…

Short-Term Stays

• Have average guest stays of 7 days or less

Material Participation

• Participate in the activity more than 500 hours per year, OR
• Have substantially all participation performed by you or your spouse, OR
• Participate of more than 100 hours AND more than anyone else, OR
• Materially participate in this activity for 5 of the last 10 years

Like everything in the tax world, this sounds complicated because it is. But it’s not impossible to implement if you have the right help along the way.

Other details to keep in mind:

• •Participation hours in real estate activities need to be “customary” (i.e. normal) for owners to perform.
• •Participation by taxpayers and their spouses both count towards the hours tests, whether or not both are listed as owners of the property
• •Hours spent on investor-like activities such as general research, reviewing financial statements for investment purposes, etc. also don’t count.
• •Keep personal use of any rentals to less than 14 days (or 10% of rental days). This avoids having the property inadvertently classified as a vacation home.

Participation Log

Logging your hours is the most straightforward way to prove material participation. Here’s a link to a simple template you can use to log yours.

📋 Material participation hours log.

Another exception that unlocks passive tax losses for rental real estate is qualifying for Real Estate Professional Status (REPS).

REPS itself is taxpayer specific, not property specific, and typically is used with longer-term rentals. A taxpayer must still materially participate in each activity for those to qualify as non-passive.

Qualifying for REPS is a high standard and doesn’t always fit everyone’s circumstances, especially if you have a day job or another business.

These are the requirements for REPS…

Both of the following must be true:

• You must perform more than 50% of all your services in real estate activities, AND
• You must participate more than 750 hours per year on real estate

Remember that if you as the taxpayer meet REPS qualifications, each separate real estate activity you’re involved with also needs to meet the material participation tests we talked about above.

REPS works best if you’re already working in real estate or if your spouse doesn’t have a full-time job or significant other business activities.

Other details to keep in mind:

• •Getting a real estate license or setting up an LLC for a rental property doesn’t by itself qualify you for REPS.
• •For REPS status, only one individual’s services can qualify. In other words, spousal activities don’t count towards the 50% or 750 hours tests.

Participation Log

Logging your hours is the most straightforward way to prove you meet the two REPS tests. Here’s a link to a simple template you can use to log yours.

📋 REPS hours log.

There you have it! Now you know three real strategies to save taxes using real estate.

Full disclosure, knowing about these strategies is one thing, but understanding if you qualify and then safely implementing them can be a much bigger challenge.

If you aren’t sure you want to do it alone, let’s chat.

Disclaimer: This information is presented for educational purposes only and shouldn’t be construed as tax advice. For recommendations specific to your situation, please consult a licensed tax professional.