[00:00:00] Hi, everyone. This is the how to lower your tax bill 
[00:00:10] podcast. I'm your host, Terrence Hutchins. I'm, a financial and tax advisor in the Dallas Fort worth area. And the goal of this podcast is to help you listeners get 
[00:00:20] educated on different tax strategies. That you can implement to improve your tax situation immediately? Each episode, we'll break down useful tax tips you can use to save 
[00:00:30] money no matter what your personal or business income situation. Because our motto is keep more of what you earn. So let's get into today's [00:00:40] episode. All right, we are fully into tax season now 
[00:00:50] and we have been talking through this idea around W-2 filers and how real estate can impact their tax bill. We've talked about three different [00:01:00] options that they have as far as how does real estate actually help you reduce your tax bill if you still keep your W-2 job.
So number one, You make less than 
[00:01:10] $150,000 and you have a real estate loss where you can deduct up to $25,000. Number two, you own a short term rental, which as we talked about last time, 
[00:01:20] short term rentals are not considered rental activities, meaning the average stay for your guest is seven days or less and you don't provide substantial 
[00:01:30] services and the average stay is 30 days or less.
In that case, if you have a short term rental that on paper loses money, you can use that loss to offset your W-2 
[00:01:40] income, which will also reduce your tax bill. Then you have this third place where if you have a W-2, or you have a spouse that, uh, doesn't work [00:01:50] full time, then you can potentially be considered a real estate professional. And so this real estate professional status, just to give you a little background. So back in 
[00:02:00] 1986 is when these whole passive activity loss rules happened. Okay, 1987 was a really good year. You might use your imagination as to why for me personally. 
[00:02:10] But in 86 they passed these rules. That's where this tax code 469 comes into play, where a lot of these rules are evident. So if you want to get some 
[00:02:20] good late night reading, you can pop up 469 on the tax code and kind of read through that. But, to cut through some of that noise, 469 essentially said, Hey, all these people that are making 
[00:02:30] all this money, they were trying to buy real estate to reduce their taxes. We're going to put it into that, and we're going to put these passive activity loss rules in.
So that's where now you basically have to 
[00:02:40] kind of go outside the box where you have that $150,000 income limit, where if you make over that, you can't use your real estate losses unless they're short term or you're considered a real estate professional, 
[00:02:50] which came into play in 1993 because people who are actually realtors or people who are developers, they were thinking, Hey, we actually are doing this full time. This is our job. 
[00:03:00] And we're buying real estate actively and we shouldn't be penalized because these other people aren't trying to take advantage of the tax laws that are in place. Okay. So like any [00:03:10] good citizen, you complain to your congressman and your congressman create laws. And that's where now we have a real estate professional, which they essentially said 469 
[00:03:20] Code Section C seven to qualify as someone who is a full time real estate professional, then you have to meet two different tests. Number one, you have 
[00:03:30] to have it be your full time job so you cannot work another job more than you work in real estate. if you decide to go that route and you do decide to work another job, just know
[00:03:40] that If you're full time in that job or you have full time hours, even if you theoretically decided to say, Hey, you know what I work 2000 hours in this job and I 
[00:03:50] work 2100 hours in real estate, the IRS isn't going to believe you.
All right, they're just going to say, Hey, we don't believe your time log. You can track it, but we just don't think that you have that many hours in a 
[00:04:00] day. So if you do have a part time job, just make sure it's very, very part time. If you decide you want to do this real estate professional. So you have to have it as your full time job and you 
[00:04:10] have to have at least worked 750 hours for the year. So it's about 15 hours a week. Now, the good thing is if you're married and you have a full time job, your spouse can qualify as 
[00:04:20] a real estate professional and that impacts the both of you directly. So if your spouse is a full time real estate professional, and you have losses on joint property that you buy because they're a full 
[00:04:30] time real estate professional you can actually use those losses from your real estate to offset your W-2 income. That's an important thing because a lot of higher earners, they may have spouses that don't 
[00:04:40] work as often or they work part time and they work at all. And so you think, hey, if we can get you interested in real estate, then that'll be an avenue for you to introduce these 
[00:04:50] tax losses. What activities would actually qualify for a real estate professional? So, some real estate activities that would work are developing land, 
[00:05:00] redeveloping or improving properties, constructing new buildings. Renovating buildings, buying properties, converting current properties, renting out properties, operating or managing 
[00:05:10] properties, leasing properties, or acting as a real estate broker.
So effectively you can be a real estate agent, you could be a property manager, you could be a house flipper, you can be a real estate developer. 
[00:05:20] Alright? So those are things that would all work. Now if you worked at a real estate company. the hours that you have, you have to be a more than 5 percent owner. So you can't say, hey, I work at a construction 
[00:05:30] company, does that count? Well, if you're a more than 5 percent owner, those hours would count as far as the real estate professional status is concerned. So, if this is your full time job and it's easy, like you're a full [00:05:40] time realtor, and you're, you know, selling a lot of houses, or you're a full time house flipper. You probably don't really have to track your hours so much, but for most other people, if this is kind of what you do and you're just 
[00:05:50] barely scraping by to get to your 15 hours, then you're definitely going to want to track those. So we talked about last time how, as far as hours are concerned, education hours, travel hours. Those 
[00:06:00] generally are not going to count.
Uh, not that you won't have any, potentially, but certainly don't make that a material amount of hours that do count. Because if you have to sit across from an 
[00:06:10] auditor or go to tax court, You don't want to have, hey, I spent, you know, 20 hours on TikTok or YouTube learning about real estate because that's just not going to fly in court.
[00:06:20] Now, if it was an hour or two and they can clearly see, okay, you had plenty of hours or maybe you had 800 hours and, 40 of them were education, then you're still going to be good as far as the total. So, a few 
[00:06:30] things when it comes to married couples. So if my spouse is a real estate professional, they do over 750 hours. Secondly, I also need to materially 
[00:06:40] participate in the projects that I own. So, I can't say, okay, I'm a real estate professional, I do over 750 hours, but I only invest in real estate syndications. So, I'm really hands off. 
[00:06:50] That's not going to fly. So, you have to be a real estate professional and you have to materially participate in the activity. Which, for material participation rules, your spouse's hours could work. 
[00:07:00] we talked before, so not to get too jumbled up here, but we talked before about material participation. So materialization participation essentially says, do you work a 
[00:07:10] hundred hours or more on a specific activity and more than anyone else, or do you do all the hours or do you do 500 hours in the activity?
So in this case. If you have 
[00:07:20] one property or two properties or three properties, do you work a hundred hours or more on each of those individual properties? Or do you work 500 combined? Now, if you, let's say you 
[00:07:30] work 200 on each property, that means you materially participate in each of those activities. And then you buy a fourth property that is kind of turnkey, that you really don't have to be involved with. Or 
[00:07:40] you only, work a few hours on it during the year. You can actually do what's called a grouping election, so you can combine your hours. So, if I have 600 hours combined between all my 
[00:07:50] properties, I can have the IRS think of it as one activity. One point to realize is that if I do that, and I sell a property. Well, actually, before I say that, let me take a step 
[00:08:00] back and acknowledge. Number one, real estate professional status is a year by year thing. So year one. I can convince my wife. Hey, you like real estate. 
[00:08:10] Let's do this thing together. Of course, if it was my wife, don't worry. She doesn't listen to the podcast. She'd probably back out in a year or two. But first year, we get her to be a real estate professional. We 
[00:08:20] try to take as much advantage of our tax losses as possible in that year. So we do our cost segregation studies. We do all that in that first year. To say, hey, she qualifies. We're going to 
[00:08:30] take our losses in year one. Now if I had prior year losses, those still stay suspended. So I can't take those losses unless I 
[00:08:40] sell the property. If I have prior losses, and you see those losses on the form 8582 of your tax return. So if I've been in real estate and I've been 
[00:08:50] accruing these losses, I'll see those on that form. how many of them can apply in the current year. How many of them carry forward to future years? I can't use those suspended losses 
[00:09:00] unless I actually sell the property. However, if I do this grouping election, now my losses are all tied in together into this one activity, which 
[00:09:10] means if I have 10 properties, that's considered one activity. So I cannot use my losses unless I get substantially rid of all my properties, which generally 
[00:09:20] means I got to sell all 10 of those rentals in order to claim those losses. So this is an important thing for you to consider that. Okay. I have to look at, okay, what was my history prior to becoming a real estate 
[00:09:30] professional? And then what is my history moving forward? Once I take this election, I know everything is going to kind of all be in there together. And so I think it's important to determine, like I said, 
[00:09:40] since real estate professional status is a year by year thing, you want to also think, okay, what properties I'm going to be selling and do I want to delay maybe trying to hit this status so that 
[00:09:50] if I wanna take losses against a current property, I can, or maybe, hey, I'll do a 1031 exchange. I'll keep kind of pushing the can down the road and then I'll, you know, maybe use those 
[00:10:00] losses eventually down the road whenever I sell out of my properties. So those are all things that need to go hand in hand as it relates to your overall strategy. And 
[00:10:10] so taxes is one component, as I've reiterated before, but it really requires you to be thoughtful around. What's my tax situation today? What's my tax situation potentially going to be 
[00:10:20] like in the future? And then what is my ultimate investment strategy that's allowing me to get to my goals so that the taxes become a cherry on top and I keep more money in 
[00:10:30] my pocket, but ultimately I'm moving towards an objective that I ultimately want to accomplish. If you want to get into real estate and you currently have a W 2 job, then you need to 
[00:10:40] decide, all right, am I going to go full time into real estate? Am I going to be a developer, an agent, a property manager, or a house flipper? If I do that, and I also want to own long term 
[00:10:50] rentals, then I can deduct the losses against my income that I make from my full time activity in real estate. Or do I want to get my spouse [00:11:00] involved in real estate and have them accrue enough hours, 750 for them to be considered a real estate professional so that I can take the real estate losses we have and offset them against 
[00:11:10] my W2 income. It's a year by year thing. You need to track your hours. Remember, education hours and travel hours aren't going to be substantially 
[00:11:20] able to count towards your total hours for the year. You also have to materially participate in the activity. So that means that either you're going to Individually spend 100 hours or more on 
[00:11:30] each rental activity that you have and more than anyone else, or you're going to combine your hours across all those activities and do what's called a grouping election so that you can effectively 
[00:11:40] look at your real estate as one big activity and all the hours that you spend count for material participation purposes. So let us get into our tax 
[00:11:50] case for this week. I'm actually going to talk about five different cases. so there was a case in 2012, 2013, 2010, 2011, and 
[00:12:00] 2018. And in these five cases, there's, you know, Jindy vs. Commissioner, Trans vs. Commissioner, a few other names that I can't [00:12:10] pronounce. But basically all either tried to say that they are real estate professionals or they tried to take passive losses against their income when they weren't able 
[00:12:20] to. In the past, we had to apply for a penalty because I've had tax practitioners who will treat rental losses as active and then they'll use that to reduce your taxes. And then all of 
[00:12:30] a sudden you're getting this refund. You're all high fiving and excited. But then the IRS hits you with a notice that says, Hey, we're going to adjust your tax return or, Hey, we're going to audit your tax return. Now, these five 
[00:12:40] people, just look at the court cases. It seems like none of them really had great cases. They didn't have the proper amount of hours. They weren't real estate professionals or they didn't materially participate 
[00:12:50] in the activity. And so if you are taking one of these positions, you're going to want to make sure that you follow the rules. You document things improperly, and you see how it's being reflected on your tax return. 
[00:13:00] Because ultimately, you're responsible for your tax return. Even though someone else prepares it and signs it, you're ultimately responsible. And so it's important to keep these rules in mind.
Know that, 
[00:13:10] hey, there are things you can do to reduce your tax bill, but we gotta play by the book. So next week we'll go into some additional real estate tax strategies and until 
[00:13:20] then keep more of what you earn.