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Do You Materially Participate in Your Rentals?

There are significant tax advantages to individuals that qualify as a real estate professional,and can demonstrate that they materially participate in managing their rental properties.  This classification opens up the ability to write off higher rental losses and also allows for the exclusion of the 3.85% tax on net investment income from rental properties.   The tests can become somewhat cumbersome and we are here to ensure that  every option has been examined and any possible steps that can be implemented are implemented in order for you to qualify as materially participating in managing your properties.  The following steps are used to determine if an individual qualifies as materially participating:

Step 1 - Identify the hours you (and spouse, if applicable) spent working on each real property trades or business in which you participated during the year:

  • Development

  • Redevelopment

  • Construction

  • Reconstruction

  • Acquisition

  • Conversion

  • Rental

  • Operation

  • Management

  • Leasing

  • Brokerage

Step 2 - Test material participation in real property trades and businesses

Determine if you meet any of the following criteria using the hours from step 1.  If married include hours for both spouses (you only need to satisfy one criteria). 

  1. Your participation hours in a single trade/business are greater than 500.

  2. Your participation in a single trade/business is substantially all of the participation in that trade/business (including non-owners).

  3. Your participation hours in a single trade/business are greater than 100 and your participation hours are more than anyone else that participated in the trade or business.

  4. You have 100 or more participation hours in multiple trades/business and your total hours in all of these trades/businesses exceed 500 hours for the year.

  5. You meet the material participation requirements (1-4 above) for 5 of the previous 10 years.

  6. You materially participate in a personal service activity for any of the three proceeding tax years (not required to be consecutive).

  7. A general facts and circumstances test for certain circumstances. 

Step 3 - Limit hours to only the individual participating in rentals

Exclude spouses hours included above, if applicable, and apply the following two tests:

  1. More than 1/2 test - the hours you spent materially participating in real property trades/businesses must exceed the hours you spent on non-real property businesses (other jobs).

  2. 750 hour test - the hours you spent materially participating in real property trades/businesses must exceed 750 hours.

If you have passed all the tests so far, congratulations, you are a real state professional, but there is one more test!

Step 4 - Determine your participation in your rentals - and only your rentals

Notes for Step 4:

  • Only include hours for the one person participating in the rental (exclude spouse hours).

  • All rentals are measured separately, unless an elections is made under Section 1.469-9 to aggregate all rental activities.

  • Meet one of the following 3 tests:

  1. Your participation hours in each rental (aggregated, if applicable) is greater than 500.

  2. Your participation hours in each rental (aggregated, if applicable) is substantially all of the participation in that trade/business (including non-owners).

  3. Your participation hours in each rental (aggregated, if applicable) are greater than 100 and your participation hours are more than anyone else that participated in the trade or business.