Real estate investors often struggle with counting real estate professional hours. If you claim status as a tax law–defined real estate professional who can deduct his or her rental property losses, your time record for the year must prove that you spent
- more than one-half of your personal service time in real property trades or businesses in which you materially participate, and
- more than 750 hours of your personal and investor services time in real property trades or businesses in which you materially participate.
Counting real estate professional hours correctly is very important however it gets tricky most of the time especially when identifying what hours count and does not count towards that 750 hours threshold.
Fortunately, the IRS released some helpful instructions in Publication 925, and those did a great job of highlighting both opportunities and risks.
Counting Real Estate Professional Hours
The first thing you should know is you need to have a system for counting your real estate hours.
A taxpayer-friendly rule is provided in Publication 925 and it goes like this:
“Proof of participation. You can use any reasonable method to prove your participation in an activity for the year. You don’t have to keep contemporaneous daily time reports, logs, or similar documents if you can establish your participation in some other way. For example, you can show the services you performed and the approximate number of hours spent by using an appointment book, calendar, or narrative summary.”
To put it another way, you can prove your time in pretty much any credible way. You must indicate the actual services you rendered but estimates work too.
Real Estate Professional Hours Categories
Publication 925 also delves into the types of services that qualify as real estate work.
A real property trade or business is a trade or business that does any of the following with real property.
- Develops or redevelops it.
- Constructs or reconstructs it.
- Acquires it.
- Convert it.
- Rents or leases it.
- Operates or manages it.
- Broke it.
What Hours Count And Does not Count For Real Estate Professional Status
Any work you conduct in connection with an activity in which you hold interest is viewed as involvement in the activity. Collecting rent, bookkeeping, advertising, maintaining legal compliance, safety reviews, inspections, decorating, tenant approval, contractor supervision, procuring insurance, paying taxes, and actual hands-on maintenance are all tasks that count toward your hourly requirements.
However, there are also activities that does not count in hourly requirements:
Travel: While you can deduct mileage and expenses for travel to and from your rentals, the time spent traveling is considered commuting and does not count against your hourly thresholds. However, according to the IRS position stated in Tax Court Memo 2012-83 (Trzeciak), if you are also claiming a home office that is used frequently and exclusively for your real estate business, you can consider the time spent traveling.
There is also some precedent that says no. Unless a taxpayer can prove day-to-day managerial engagement, travel time is considered commuting, which is personal in nature, and so does not qualify, according to Tax Court Summary 2003-130 (Truskowsky). This is a bit of a gray area, so a further debate is needed.
If you did not claim a home office on your tax returns, you should do so immediately. Travel time can be successfully contested if the home office is used on a regular and exclusive basis and if proof and day-to-day involvement are provided.
Research: Many investors who claim to be on real estate professional status research other investment properties to fill in the gaps left by their hourly obligations and day-to-day engagement. While this appears to be a fair stance, the IRS and the Tax Court have rejected it as investor activities rather than real estate operations. Find something else to do with your time—mow the lawn, search and peck your QuickBooks entries—but do not count your Zillow hours.
Investor: Unless you are directly involved in the day-to-day management or operations of the activity, the work you conduct as an investor in an activity is not treated as involvement. As an investor, you are responsible for:
- Examining and analyzing financial statements or reports on the activity’s operations,
- preparing or compiling summaries or evaluations of the activity’s finances or operations for personal use, and
- In a non-managerial capacity, monitor the activity’s finances or operations.
These activities are valid as long as you can show that you are involved in them daily. This is significant since the IRS considers rental activities that do not require day-to-day involvement to be presumptuous.
Spouse Participation: Remember that your spouse’s material participation in an activity is included in yours. Even if you and your spouse did not possess any interest in the activity and did not file a joint return for the year, this rule applies. It is important to note the word “material,” since you will need to show that your spouse’s time was crucial to the rental activity or operation.
There are a number of other “horror stories” regarding investors and real estate professionals being denied time spent on other activities that appear to be related to real estate. Some of the stories seem to revolve around the auditor, how they interact with the auditor or just bad information.
If you need further guidance on this, do not hesitate to reach IDM Professional Corporation CPA.