Qualifying as a real estate professional for tax purposes can change how your rental losses are treated. Paired with cost segregation, it can also create large deductions against your other income. This guide explains the rules and the benefits.
Who qualifies as a real estate professional?
Under Section 469(c)(7), you qualify as a real estate professional for a year if you meet both tests:
- More than half your working time. Over half of the personal services you perform in all trades or businesses must be in real property businesses where you materially participate.
- At least 750 hours. You must also spend more than 750 hours in those real property businesses during the year.
For married couples, one spouse must meet both tests alone. Also, hours as an employee don’t count unless you own at least 5% of the employer.
Why real estate professional status matters
Normally, rental activities are passive. So rental losses can only offset passive income. However, a real estate professional who materially participates in their rentals can treat those losses as non-passive. As a result, the losses may offset wages, business income or investment income.
Material participation
Material participation means regular, continuous and substantial involvement. The IRS has several tests. For example, you can qualify by working more than 500 hours on the activity. Alternatively, you can work more than 100 hours and more than anyone else. Many owners elect to treat all their rentals as one activity, which makes these tests easier to meet.
How cost segregation adds to the benefit
Cost segregation is a study that splits a building’s cost into parts. Some parts, such as certain fixtures, equipment and land improvements, can be depreciated over 5, 7 or 15 years. By contrast, the building itself is depreciated over 27.5 years for residential rentals or 39 years for commercial property.
These shorter-life parts may also qualify for bonus depreciation. The 2025 tax law restored 100% bonus depreciation for qualifying property acquired after January 19, 2025. So a cost segregation study can create large first-year deductions.
Benefits for real estate professionals
- Faster deductions. More of the property is written off in the early years.
- Offsets to other income. Because the losses are non-passive, they can reduce tax on your wages or business income. However, the excess business loss limit may cap how much you can use in one year.
- Better cash flow. Lower taxes free up cash to reinvest.
Learn more about our cost segregation services, which we provide through a partner firm.
Keep strong records
The IRS closely reviews real estate professional claims. So keep a detailed, contemporaneous log of your hours and activities. For the official rules, see IRS Publication 925, Passive Activity and At-Risk Rules.
Talk to us about real estate professional status
We help real estate investors plan for professional status, document their hours and coordinate cost segregation. To discuss your situation, call (415) 842-2940 or book a free 15-minute call.