A “real estate professional” isn’t a casual title or designation, but a specific status recognized by the Internal Revenue Service (IRS) that holds considerable weight in the business world courtesy of the financial and tax benefits it bestows its holder.
A real estate professional, in the context of tax law and IRS regulations, is someone who meets specific criteria related to their involvement in real property trades or businesses.
This post will outline the specific requirements to achieve this status and the challenges medical practitioners may face while contemplating such a drastic career refocus.
Key Takeaways
- Real estate professional status offers tax benefits like PAL relief and NIIT exemption.
- Meeting the IRS criteria requires 50%+ personal services and 750+ hours annually in real estate.
- Material participation in rental activities is crucial for maintaining professional status.
- Doctors face challenges balancing medical careers and meeting real estate professional criteria.
Table of Contents
What Are the Benefits of Becoming a Real Estate Professional?
The chief benefits of becoming a real estate professional are the relief from Passive Activity Loss (PAL) limitations and the potential exemption from the 3.8% Net Investment Income Tax (NIIT).
PAL Limitations
Normally, the IRS considers rental activities “passive income.” If you lose money on your rental properties, you can only use those losses to offset other sources of passive income, not your regular income, be it your salary or business income. This is what’s referred to as the PAL rules.
For real estate professionals, the situation is different. They can use those rental property losses to offset other income, including the income obtained through their job or business, reducing their overall taxable income and leading to significant tax savings.
As a quick example, if you lose $20,000 on your rental properties but make $120,000 from your job, you can’t use that loss to reduce taxable income from your job—instead, wait until your rental properties make money or sell them to use that loss.
NIIT Exemption
The NIIT is a 3.8% tax on certain types of investment income for high-income earners that requires knowledge of your modified adjusted gross income (MAGI), as it applies to individuals who exceed defined thresholds.
You can calculate your MAGI by adding back tax-exempt interest, excluded foreign income, and certain deductions to your adjusted gross income (AGI).
If you’re a single-filer and your MAGI exceeds $200,000, or a married couple filing jointly whose MAGI exceeds $250,000, then the NIIT becomes a concern.
How It Works
For non-real estate professionals, income generated through rental properties would be considered passive income and subject to the 3.8% tax. So, if you made $50,000 from your rentals, you’ll have to pay $1,900 in additional tax.
However, if you’re a real estate professional—and your rental activities are considered part of your ordinary course of business—that $50,000 might not be subject to the NIIT tax, and you won’t have to pay anything extra to the IRS.
What to Keep In Mind
There’s an emphasis on “income derived from the ordinary course of a trade or business” because qualifying as a real estate professional isn’t enough; your activities have to be regular and substantial enough to be considered a business.
In other words, you should be treating property rental as your regular job.
Combined with relief from PAL limitations, the NIIT exemption can help you save substantially more on taxes. However, taxes are a complex subject, and calculating your exact AGI and MAGI can be a headache in and of itself. Approaching a tax professional for advice that matches your individual circumstances is the best option.
What Are the Requirements for Becoming a Real Estate Professional?
Obtaining the status of a “real estate professional” requires you to meet three main criteria that you’re tested against annually; your status can change from year to year based on meeting these tests.
The 50% Test
First, you must perform more than 50% of your personal services in real property trades or businesses.
These services include real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, and brokerage, and you must keep detailed records to document the time spent.
Note that the time spent as an employee in real property trades or businesses doesn’t count unless you own 5% or more of the company that employs you. Additionally, this test’s requirements, as well as the 750 hours test, must be met by one spouse alone if filing jointly
The 750 Hours Test
Second, you must perform more than 750 hours of service in real property trades or businesses, while keeping detailed records, such as appointment books, calendars, or narrative summaries, to prove hours worked in real estate versus other businesses.
While the IRS doesn’t require a specific time format for records proving your 750 hours of service, they are nonetheless strict regarding this criterion and need to see reasonable documentation that supports the hours claimed. This is chiefly to prevent abuse—as the tax benefits of real estate professionals are substantial—and to preclude false claims to the status.
This is separate from the 50% test but works in conjunction with it. If the 750 hours you worked in this business made up more than 50% of your personal services, you’d satisfy both criteria.
Material Participation Test
Third, you must participate materially in each rental activity. To be considered a “material participant,” you must meet at least one of the following criteria:
- Work more than 500 hours in the activity,
- Do substantially all the work,
- Work more than 100 hours and more than anyone else,
- Participate materially in the activity for any 5 of the last 10 years,
- Participate materially in a personal service activity for any prior 3 years, or
- Participate regularly, continuously, and substantially, based on facts and circumstances.
Unlike the 50% and 750 hours tests, the hours of both spouses can be counted in this test.
Material participation is determined separately for each rental property unless the taxpayer chooses to group all their rental real estate activities and treat them as one combined real estate business for tax purposes.
Becoming a Real Estate Professional as a Doctor: What to Expect
Medical practitioners work long, irregular hours, which makes it nearly impossible for them to dedicate the required 750 hours, or 50% of their personal services, to real estate activities without reducing medical practice hours.
In fact, doing so would consequently impact their income and be a financially risky move, as doctors often have unresolved student loan debt and high-cost lifestyles that a real estate novice won’t be able to afford.
That’s not to mention the challenges presented by the legal and psychological aspects of the job: regulatory compliance and license maintenance, work-life balance, extensive record keeping, and such.
Strategies for Doctors to Become Real Estate Professionals
Here are a few tips, focusing on particular issues, to assist you with transitioning into real estate and potentially achieving “real estate professional” status. We provide more tips here.
Time Management
As a medical practitioner, a gradual transition into real estate is the most practical approach, as it’ll allow you to incrementally reduce your medical hours while increasing your real estate activities without seriously affecting your income.
You can gradually transition by hiring a locum tenens, who is a healthcare professional temporarily filling in for you, to provide coverage for your medical practice. They’ll allow you some leeway in exploring emerging opportunities and deepening your knowledge of this field while keeping your patients cared for and your income flowing.
Alternatively, you can begin providing telemedicine services; consult with your patients, and provide them remote care through video calls or online messaging. Either way, you must find a method to increase your hours in the real estate business without hurting your income or your patients’ well-being.
Education
Your clinical skills and medical knowledge must remain sharp while transitioning into the real estate business for two reasons: to remain competent and up-to-date with current breakthroughs and to fulfill licensing requirements.
Engaging in locum work or volunteering allows you to satisfy both causes while freeing up more time for real estate activities. Volunteering is particularly important, as it’ll provide you with opportunities to network with fellow professionals who may share the same interests as yours while benefiting your community.
Finally, consider online courses and webinars: many U.S. medical colleges offer them, including Stanford, Johns Hopkins, and Yale. They come with certificates of completion and contribute to your Continuing Medical Education (CME).
Medical Expertise
As a doctor, it’s best to capitalize on your existing knowledge and experience in the healthcare field when entering the real estate market. You’ll be operating in a familiar sector. As such, you’re more likely to identify emerging investment opportunities and provide more value to your community by targeting its healthcare needs.
Instead of rental properties, vacation houses, and retail spaces, consider investing in diagnostic centers, medical office buildings, assisted living facilities, and the like.
Differently, you can leverage your insider’s perspective on current trends and developments in the healthcare industry to make informed investment decisions. If you don’t want to buy, manage, or finance properties yourself, invest in healthcare Real Estate Investment Trusts (REITs).
Finances
Finally, expect the transition to be difficult and, in the worst-case scenario, an endeavor that might not pay off and isn’t worth jeopardizing your financial security and professional identity.
Approach it with a healthy dose of caution by continuously reassessing your financial position and developing a sound retirement plan and exit strategy if your expectations aren’t met.
Plan Your Transition Into Real Estate with Physicians Thrive
While the transition from medical practice to real estate can offer exciting opportunities, it’s a significant undertaking that requires financial acumen and careful planning, particularly in regard to time.
As you contemplate this transition, consider familiarizing yourself with the real estate market, seeking advice from financial advisors, and contacting accomplished medical professionals with experience in the field.
For comprehensive guidance on navigating this career shift, from licensing considerations to tax implications, visit Physicians Thrive—a resource designed to support doctors in all aspects of their professional journey.
