THIS WEEK'S STORY
Your LLC Does Not Make You a Real Estate Professional
“I formed an LLC and paid for a cost-segregation study. Why can’t I deduct the loss?”
That was the question Mark asked me after buying a rental property.
His cost-segregation study created a large depreciation deduction. Because he owned a construction company and worked around real estate every day, he assumed the loss would reduce his business income.
It didn’t.
Forming an LLC does not make you a real estate professional for tax purposes. Neither does owning rental property or working in a real-estate-related industry.
You generally must pass two annual tests.
First, you must spend more than 750 hours in qualifying real-property businesses in which you materially participate.
Second, that time must be more than half of all the time you spend working in businesses during the year.
Construction, development, property management, leasing, and brokerage may count. But there is an important catch: time worked as an employee generally does not count unless you own more than 5% of the employer.
There is also a second hurdle.
Even if you qualify as a real estate professional, you must materially participate in the rental activity. Multiple rentals are generally tested separately unless you make a valid election to treat them as one activity.
This is where owners get burned.
A cost-segregation study may create a $200,000 loss. But if you do not meet the participation rules, that loss may be suspended instead of reducing your construction profit, wages, or other active income.
The deduction may still have value later. It just may not deliver the immediate tax savings you expected.
And do not try to rebuild your hours after an IRS notice arrives. Keep a reasonable calendar, time log, emails, and project records while the work is happening.
