"Real estate professional" is a special tax category for people involved in the real estate business. If you qualify as a real estate professional, you obtain some extraordinary tax benefits unavailable to other people who earn, or lose, money from rental real estate.
First, real estate professionals can treat all of their losses from rental real estate as active losses. This means they can deduct all their rental losses from all of their other income for the year, including income that doesn't come from real estate rentals. Taxpayers who don't qualify as real estate professionals can only deduct rental real estate losses from other "passive" income, such as real estate rental income or other passive investment income.
In addition, real estate professionals are not subject to the 3.8% Medicare tax on unearned income that went into effect in 2013. This tax is imposed on all taxpayers with adjusted gross income over $200,000 for singles and $250,000 for married taxpayers filing jointly. The tax applies to income from rentals and most other real estate investments, as well as other passive investments.
These tax benefits are particularly valuable for landlords with high incomes or large rental losses. They can give real estate professionals who invest in real property a substantial financial advantage over landlords who don’t qualify for them.
To qualify as a real estate professional, you must pass a complicated three-part test: You must work in one or more real estate businesses; you must work more than 750 hours per year in such businesses; and you must spend more than half of your time doing such work. A real estate business includes any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage business. Most people who qualify are engaged in one of the following activities:
But what about real estate mortgage brokers? The Internal Revenue Code doesn’t mention them specifically, but it does include people involved in the real estate brokerage business. Arguably, mortgage brokers are involved in real estate brokerage, since they market mortgage loans and bring together lenders and borrowers.
Unfortunately, the IRS Chief Counsel has concluded that mortgage brokers who are involved in financing of real property are not in the real property brokerage business for purposes of the real estate professional exemption. (CCA 201504010.) This was determined even though the licensed real estate mortgage broker involved was considered to be a real property brokerage business under state law.
The Chief Counsel reasoned that mortgage loan operations were not included within real estate brokerage because real estate brokerage involves bringing together buyers and sellers of real property. Mortgage brokers don’t do this—they bring together buyers and lenders.
All this means is that time spent working as a mortgage broker does not count if you’re attempting to qualify as a real estate professional. This is very bad news for mortgage brokers who also own rental real estate.