Rental property is a complicated subset of passive activities and making a real estate professional election can make a huge difference for people with rental losses. Real Estate Professional basically means your full time job is real estate and it allows you to switch passive rental losses to active.
Rental real estate is set up to be inherently passive in the tax code. For taxpayers with AGI of less than $100k they can deduct the first $25k of passive rental losses, but any additional losses would be suspended and carried forward. Many taxpayers with rental properties have higher incomes so they cannot deduct any passive losses.
The only way to treat rental real estate as an active trade or business is to be a real estate professional. To qualify, you must work more than 750 hours in your real estate businesses and it must account for more than 50% of your personal service hours for the year. Again, it needs to be essentially your full time job. You can’t really get a Form W-2 from 3M as a scientist and claim to be working more than half of your hours on rental real estate properties.
Another key to the real estate professional election is that it looks at each activity separately unless you make a grouping election that aggregates all your rental real estate activities into a single bucket. Having 7 different rental properties, you are probably not going to get 750 hours in one of them, so a grouping election is almost always necessary. Keep in mind that with these elections the burden of proof is one the taxpayer in any type of audit. Keeping records to prove the number of hours worked is critical to audit success. If you are truly a real estate professional, this election is very important to saving taxes if you haven’t already done it.