If you want to shelter your hard earned income from taxes using Real Estate Professional Status (REPS), you’d better know how to do it legally. In this article, we’ll show you how to stay out of trouble with the IRS by doing things the right way.
[Disclaimer: We are not accountants, lawyers, or financial advisors, so please consult your own team of professionals about the topics covered in this article.]
Before diving in, a quick disclaimer. We are not lawyers, tax professionals or agents of the IRS. We gathered the information contained in this article through years of reading, extensive research, in-depth discussions with tax accountants and attorneys, as well as claiming REPS for 9 consecutive years and running!
So if you haven’t heard about real estate professional status, let me quickly walk you through it. If you want a more in-depth article, CLICK HERE.
So what is REPS? It’s a designation that the IRS gives you if you qualify or meet certain criteria. Once you meet that criteria, it allows you to use real estate to shelter your income from your day job.
So it’s a really valuable status because it can lower your taxes significantly. In fact, we were able to shelter all of our income over the last seven years. Imagine what not paying taxes for that long would do for your net worth.
So what does it take to qualify for this status?
There are three main criteria.
The first is, you have to do a minimum of 750 hours in a real estate business. Buying and operating rental properties counts as a real estate business.
The second is you need to spend more time in real estate than in any other profession. So that means, if you’re a doctor, you need to do more hours in real estate than the time you spend seeing patients.
The third is something called material participation. Material participation means that you’re involved in your rental business in a regular, continuous and substantial way. The IRS lays out seven material participation tests and you only have to meet one of them. The one that most real estate professionals use is the 500 hours test. This means you spend at least 500 hours on properties you own.
OK so now that you know how to qualify, the question is, how do you do it legally?
First, you want to take this designation seriously. One way to do it is by claiming the identity of being a real estate professional. Not a real estate amateur. A professional. One symbolic move I made when I was filing my taxes was listing myself, not as a doctor, but as a real estate professional. Bottom line is that I was really serious about building up our real estate portfolio and we wanted to grow it big.
Claiming the identity of a real estate professional on our tax forms!
Second, be really involved in your properties. Really spend some time working to improve them. You can do this by asking yourself three questions. 1) How can I increase the revenue that my properties generate 2) How can I decrease expenses and 3) How can I improve the living conditions for my tenants in a cost-effective way. If you ask yourself these questions regularly, you will come up with lots of ways to improve your property.
Third, document what you’re doing! You really have to keep good records of your day-to-day activities. The IRS isn’t just going to take your word for it. When you’re audited, they’re going to want you to prove it! So be really diligent about documenting your hours. One of the best ways to do it is to set aside time in your calendar each week to record your hours. As one of our mentors taught us, “if you don’t schedule it, it’s not going to happen!”
Fourth, always be pushing yourself to grow as a real estate professional. I remember when we got to 40 doors and replaced my salary, I said to Leti, “why don’t we just stop buying, pay off the loans, kick back and relax?” We even took a year off to travel. What I soon realized was that not only would it be hard to get the hours I needed, I wasn’t fulfilled. Ultimately I came to the conclusion that I had to keep challenging myself to grow as a real estate professional and that’s what I did. Since then, we’ve grown our portfolio to over 150 units and we also have syndicated another 600 units.
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Now that you know the four ways to legally qualify for real estate professional status, it’s time to go out and buy some properties! If you want to accelerate your journey to freedom by learning the right way to buy properties and limiting mistakes that can set you back years, consider taking our signature course, Zero to Freedom. You can either sign up for our waitlist or if you’re ready to get started, set up a call with our experience team.
