Now that tax season is upon us, you may wonder if the revenue that you generated from your rental property is considered active or passive income. The general rule is that income derived from real estate activity is passive and is subject to the Passive Activity Loss Limits.
This is the general rule unless you or your closely held C corporation (C corp) qualifies as a real estate professional. That's right: Your closely held C corp can be considered a real estate professional for tax purposes. Let's take a deeper dive into the regulations and learn how this plays out.
How to qualify as a real estate professional
According to the IRS, a closely held C corp can qualify as a real estate professional if more than 50% of the gross receipts for the entity’s tax year came from real property trades or businesses in which it materially participates. The IRS defines a real property trade or business as any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business. Additionally, the material participation requirement applies separately to each rental activity (unless the C corp has made the irrevocable election to group all the rentals as a single activity).
Now that we know how a C corp qualifies as a real estate professional, you may also have a few questions related to closely held corporations and C corps. Let’s go a little further into what exactly these entities are.
What is a closely held C corporation?
A closely held C corp is a corporation in which five or fewer shareholders own (directly or indirectly) more than 50% of the stock at any time during the last half of the year and it is not a personal-service corporation.
A C corp is a legal entity in which the shareholders (the owners of a C corp) are taxed separately from the entity. If you're interested in forming this type of arrangement, you should consult with your legal or tax advisor before doing so. This will help you ensure all the appropriate filings are submitted to the correct organization.
Millionacres bottom line
To maximize the amount of your deductible losses and not face the limitations of the passive activity loss rules, you'll need to plan ahead of the tax season. Qualifying as a real estate professional, if applicable, is one of the planning tools you should consider. In order to qualify, you or your corporation must meet the IRS’s definition of a real estate professional. This is the rule even if you have a state or local license. This is where careful tax planning comes into play. You should not endeavor into the terrain of tax code alone. Consulting a tax professional is always the safest way to go!