Real Estate Professional Status (REPS)
By Jason Watson, CPA
Posted Sunday, May 25, 2025
Why designate yourself as a real estate professional? Aside from being something cool to tell the grand kids, let’s presume that you have a loss on your rental property or in aggregate on your gaggle of rental properties. It is common to have a tax loss on your rental activities although it cash flows, and the primary reason is depreciation. How does this tax loss affect your tax return?
As a reminder, IRC Section 469 defines a passive activity as any activity that involves a trade or business in which an individual taxpayer does not materially participate. Passive losses and material participation are trigger words to make any real estate investor twitch.
Rental income is typically considered passive, meaning that you are not directly earning the income as you would with a W-2 job or as a small business owner. Generally, passive losses may be deducted from passive income. For rental income there is an exception allowing you to deduct passive losses from non-passive income such as wages and business income but there are limits (of course there are!). Passive loss limits for married taxpayers max out at $25,000, and that number decreases as your gross income increases. Yuck!
Specifically, passive activity loss limits reduce $1 for every $2 over $100,000 modified adjusted gross income (MAGI) and by $150,000 (for married couples) the passive loss deduction is $0. Bummer. For a deep dive into passive activity loss limits including how to calculate MAGI, see our passive activity loss limits section.
Not all is lost, however. If your rental losses are capped or disallowed (unallowed is the official word) because of passive loss limits, the portion exceeding the passive loss limit is carried forward on Form 8582, aggregated for each year and may be deducted in the year of disposal (sale). They may also offset future net rental income; you had losses, they were carried forward, you now have rental profits and the suspended losses can be used to offset. We call these PALs (passive activity losses). Sounds fun. Your PAL will come to assist when you have passive income.
Spoiler Alert: If you qualify for REPS on your rental properties, the prior losses carried over on Form 8582 remain stuck unless you sell or have net rental income (profit). You can’t roll up with your REPS membership card and expect yesterday’s dirty laundry to be clean (yeah, we probably took that too far).
There is another angle to all this, and this is the gist of this section- if you are a real estate professional who materially participates in rental activities, as defined by the IRS, and not your bartender, you can deduct 100% of your rental property losses (you are not capped by passive loss limits). This makes sense since your rental income is no longer passive if it is your livelihood or at least a large portion of your livelihood. In other words, the real estate professional status (REPS) is essentially telling the IRS and the world that your rental activities are not something you tend to from time to time but rather are approached with the mindset of a busy business owner.
But wait! There’s more. When the Net Investment Income Tax (NIIT), which was introduced along with the Affordable Care Act, the real estate professional designation became an important tax planning tool all over again. Huh? If your modified adjusted gross income (MAGI) hits a certain amount, the NIIT is charged on all portfolio (interest, dividends, capital gains) and passive activity income (rentals). However, if you are a real estate professional your taxable rental income (profits) is no longer deemed passive and as such is not being taxed by the net investment income tax of 3.8%. $100,000 in rental profits multiplied by 3.8% for 20 years. That could be huge!
Here is a mini agenda and references to other sections of our book-
- Qualifying as a Real Estate Professional
- Passive Activity Losses and Their Limitations
We gloss over passive activity losses, material participation and qualifying hours since we covered these topics in depth on the pages above.
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