The Real Estate Professional Tax Status Explained – A Guide for Doctors

The real estate professional tax status is an IRS-recognized designation afforded to anyone who operates in the real estate industry.

Eligible professionals need to engage in trade or business activity related to real estate.

Think estate agents, property developers, investors, and the like. They’re also required to satisfy the IRS’s qualification criteria.

If you’re wondering whether medical professionals like yourself can achieve real estate professional tax status, this article aims to provide some clarification.

We discuss the requirements, pros, cons, and more, and put to bed the question of whether the title is exclusively meant for dedicated real estate professionals.

Key Takeaways

• Qualifying for the professional tax status requires material participation in real estate-related activities.
• IRS-recognized activities for real estate professional tax status qualification include property development/redevelopment, construction, acquisition, conversion, rental, management, leasing, and brokerage.
• The benefits of acquiring this tax status include a reduction in tax liability, the ability to treat passive income as active income, and long-term capital gains.
• Potential challenges and drawbacks to getting this status include the time commitment requirement, changing tax laws, and increased paperwork.

IRS Qualification Criteria for Real Estate Professional Status

The IRS sets out two criteria in its 2023 Publication 925 that individuals who want the real estate professional tax status must meet. In the agency’s words:

“You qualified as a real estate professional for the year if you met both of the following requirements.

• More than half of the personal services you performed in all trades or businesses during the tax year were performed in real property trades or businesses in which you materially participated.
• You performed more than 750 hours of services during the tax year in real property trades or businesses in which you materially participated.”

In other words, you need to have materially participated in property-related activities to qualify.

Notably, the IRS doesn’t impose professional criteria on individuals.

The lack of these requirements signifies that tax status is open to all, regardless of their main profession (this includes doctors).

Real Property Business Activities Recognized by the IRS

Section 469(c)(7)(C) of the Internal Revenue Code recognizes the following activities as constituting real property trade or business:

If you can establish material participation in one or more of the above activities, the IRS may deem you to be a qualifying real estate professional.

Real Estate Professional Tax Status Obligations

Based on the IRS’s requirements, it’s clear that:

• doctors can qualify for real estate professional tax status; and that
• establishing material participation in one of the 10 IRC-defined real property trade or business activities is crucial for qualification.

But what is material participation?

The IRC sets out material participation tests you can use to prove your involvement in real estate activities (and qualify for tax status).

As quoted from the document:

“You materially participated in a trade or business activity for a tax year if you satisfy any of the following tests.

1. You participated in the activity for more than 500 hours.
2. Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who didn’t own any interest in the activity.
3. You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who didn’t own any interest in the activity) for the year.
4. The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you didn’t materially participate under any of the material participation tests, other than this test. See Significant Participation Passive Activities under Recharacterization of Passive Income, later.
5. You materially participated in the activity (other than by meeting this fifth test) for any 5 (whether or not consecutive) of the 10 immediately preceding tax years.
6. The activity is a personal service activity in which you materially participated for any 3 (whether or not consecutive) preceding tax years. An activity is a personal service activity if it involves the performance of personal services in the fields of health (including veterinary services), law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital isn’t a material income-producing factor.
7. Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the year.”

In other words, you’ll need to show sufficient proof of time spent performing real estate activities before you can access the tax benefits associated with having real estate professional status.

This necessity gives rise to the following obligations:

• Record Keeping: You’ll need to keep detailed and timely records of all activities and personal services performed during the tax year. Also, you must organize all documents (contracts, invoices, lease agreements, etc) related to your real property businesses.
• Industry Participation: Attending industry-related events and brushing up on professional qualifications will give you the evidence needed to show participation in the real estate industry.

Once you can show proof of the hours spent performing day-to-day management of a property or real estate business, you can pass the material participation test.

Benefits of Real Estate Professional Tax Status

Real estate professional tax status gives you significant tax advantages. Notable ones include:

• Passive Income as Active Income: The IRS generally views rental income as passive income. As such, the amount you can deduct in rental losses tends to be subject to limitations. However, when you have this tax status, you can treat your rental income as active income and deduct any losses incurred without restriction.
• Reduced Tax Liability: Being able to deduct rental losses without issue means you can significantly reduce your tax liability. For example, you can avoid paying the 3.8% Net Investment Income Tax on your rental income, resulting in significant tax savings.
•  Long-Term Capital Gains: After selling a rental property, you can qualify for a lower tax rate as a real estate professional. We go deeper into the lower tax rates associated with capital gains in our explainer of the Qualified Dividends and Capital Gains Worksheet.

Recouping your losses and paying a lower rate on your capital gains will result in more money in your pocket in the long term.

Real Estate Professional Tax Status – Potential Challenges

As a medical professional, you should be aware of the following drawbacks to achieving real estate professional tax status:

• Time Commitment: Attaining this tax status requires a significant time investment. Per the IRS’s requirements, you have to invest more time into real estate activities than your main job. If you’re trying to start your own medical practice, you may find it challenging to find the time needed to take advantage of this tax status.
• Tax Law Volatility: Laws and regulations change as situations arise, and the laws relating to real estate professional tax status aren’t the exception. Therefore, don’t be certain that the advantages you plan to get from acquiring this status will exist by the time the new tax season rolls around.
• Increased Paperwork: If you dread the amount of receipts and other paperwork you have to present to get tax incentives, you’ll need to keep track of even more of them.

In summary, the time and resources required to attain and maintain this tax status may preclude up-and-coming medical professionals from pursuing it.

Final Thoughts

Attaining real estate professional tax status as a doctor can be challenging if you lack the time and resources needed.

Still, if you think the pros outweigh the cons, you can benefit from obtaining expert advice on how this pathway can lower your tax liability.

Contact us today for tailored advice on the best way to approach attaining and maintaining this tax status.