What Is Real Estate Professional Tax Status and Why Does It Matter?
Real estate professional tax status (REPS) is an IRS designation under Section 469 of the Internal Revenue Code that allows qualifying taxpayers to treat rental real estate losses as non-passive. For most taxpayers, rental losses can only offset other passive income. REPS removes this limitation entirely, allowing you to deduct unlimited rental losses against W-2 wages, business income, investment gains, and any other form of active income.
A commercial real estate investor with $200,000 in depreciation losses can use those losses to offset $200,000 in active income, potentially saving $70,000 or more in federal taxes alone. Without REPS, those losses sit unused until the investor generates enough passive income or sells the properties.
REPS Tax Impact at a Glance
750+
Hours Required Annually
50%+
Time in Real Estate
$0
Passive Loss Cap With REPS
3.8%
NIIT Savings on Rental Income
REPS is particularly powerful when combined with accelerated depreciation strategies such as cost segregation studies and bonus depreciation. These tools generate large paper losses in the early years of property ownership. With REPS, those losses become immediately deductible against your highest-taxed income. Without it, they remain trapped in the passive activity loss bucket.
This guide covers the specific IRS requirements for qualifying, the activities that count toward the hour thresholds, documentation best practices, and audit defense strategies. Whether you own multifamily buildings, office properties, or retail centers, understanding REPS can transform your commercial real estate tax strategy.
What Are the Two IRS Tests You Must Pass to Qualify?
The IRS requires taxpayers to satisfy two separate tests to claim real estate professional status. Both tests must be met in the same tax year, and failing either one disqualifies you entirely. There are no partial credits or carryover provisions.
Test 1: The 750-Hour Rule. You must spend more than 750 hours during the tax year performing personal services in real property trades or businesses in which you materially participate. These hours must come from activities where you have a direct ownership interest or employment relationship. Hours worked as an employee in real estate count only if you own more than 5% of the employer.
Test 2: The Majority of Time Test. More than half of your total personal services performed during the tax year must be in real property trades or businesses. If you work 2,000 hours at a W-2 job and spend 800 hours on real estate activities, you fail this test because 800 is less than half of 2,800 total hours. This test makes it extremely difficult for full-time employees in non-real estate fields to qualify.
The Two REPS Qualifying Tests Compared
Test 1: 750-Hour Rule
- Clear numeric threshold to target
- Hours from multiple real estate activities count
- Includes management, leasing, development, brokerage
- Achievable at roughly 15 hours per week
- Must be tracked and documented precisely
- Employee hours only count if you own 5%+ of employer
- Travel time to properties may not count
- Cannot count passive investor review hours
Test 2: Majority of Time Rule
- Natural fit for full-time real estate professionals
- Straightforward calculation of total hours
- Spouse qualification strategy simplifies compliance
- Part-time W-2 workers can still pass
- Nearly impossible with full-time non-RE employment
- Requires tracking ALL personal service hours
- W-2 hours are easy for IRS to verify
- Burden of proof falls on the taxpayer
The majority-of-time test is the primary reason REPS is most accessible to individuals who are self-employed in real estate, retired, or have a spouse who handles the real estate activities full time. A married couple filing jointly needs only one spouse to meet both tests. This creates a common and powerful tax planning strategy: one spouse manages the real estate portfolio while the other maintains W-2 employment.
It is critical to understand that meeting these two tests alone does not automatically make your rental losses deductible. You must also demonstrate material participation in each rental activity separately, unless you make the grouping election discussed later in this guide.
Which Activities Count Toward the 750-Hour Requirement?
The IRS defines "real property trades or businesses" broadly under Section 469(c)(7)(C). Qualifying activities include development, redevelopment, construction, reconstruction, acquisition, conversion, rental operation, management, leasing, and brokerage. Understanding which specific tasks count toward your hours is essential for meeting the threshold.
Qualifying Real Estate Activities for REPS Hours
| Activity Category | Examples | Typical Hours Per Property | Documentation Tip |
|---|---|---|---|
| Property Management | Tenant calls, maintenance coordination, inspections | 200 to 400/year | Log each tenant interaction separately |
| Acquisition and Due Diligence | Deal analysis, tours, contract negotiation, closings | 100 to 300/year | Save all emails and deal memos |
| Construction and Renovation | Contractor meetings, site visits, plan review | 150 to 500/year | Keep photos with timestamps |
| Leasing | Marketing vacancies, showing units, lease execution | 50 to 200/year | Retain listing ads and showing records |
| Financial and Admin | Bookkeeping, loan applications, tax planning | 100 to 200/year | Use accounting software with time stamps |
| Development and Entitlement | Zoning hearings, permit applications, site planning | 100 to 400/year | Save government correspondence |
Property Management Activities form the core of most REPS hour logs. These include tenant communications, lease negotiations, rent collection, maintenance coordination, vendor management, property inspections, and handling tenant complaints. Every phone call, email, site visit, and meeting related to managing your rental properties counts toward the 750-hour threshold.
Acquisition and Due Diligence hours count from the moment you begin researching potential investments. Analyzing deals, reviewing financial statements, touring properties, negotiating purchase contracts, coordinating inspections, reviewing appraisals, and attending closings all qualify. Even deals that fall through generate countable hours.
Construction and Renovation Oversight includes time spent planning renovations, meeting with contractors, reviewing plans and budgets, visiting job sites, approving change orders, and coordinating value-add projects. Investors executing capital improvement programs on commercial properties can accumulate significant hours in this category.
Financial and Administrative Tasks related to your real estate activities also count. These include bookkeeping, preparing financial reports, reviewing loan documents, working with your lending team, tax planning sessions with your CPA, and researching market conditions.
Activities That Do Not Count:
- Investment analysis for stocks, bonds, or non-real estate assets
- Time spent as a passive investor reviewing quarterly reports
- Travel time to and from properties (this is disputed, but the conservative position excludes it)
- Hours worked for a real estate employer where you own 5% or less of the company
Activities That Do NOT Count Toward REPS Hours
The following do not qualify: investment research for non-real estate assets, time as a passive limited partner, work for a real estate employer where you own 5% or less, general education or reading about real estate (unless directly tied to a property you own), and personal use of your properties. Misclassifying non-qualifying hours is a leading cause of REPS audit failures.
How Does Material Participation Work for Rental Properties?
Meeting the 750-hour and majority-of-time tests establishes your status as a real estate professional, but there is a second layer of requirements. You must also demonstrate material participation in each individual rental activity to deduct its losses against active income. The IRS provides seven tests for material participation, and you only need to satisfy one.
The Seven Material Participation Tests:
- You participated in the activity for more than 500 hours during the tax year
- Your participation constituted substantially all participation in the activity
- You participated more than 100 hours and no other individual participated more
- You participated in multiple "significant participation activities" totaling more than 500 hours
- You materially participated in the activity in any 5 of the prior 10 tax years
- The activity is a personal service activity and you participated in any 3 prior tax years
- Based on all facts and circumstances, you participated on a regular, continuous, and substantial basis
Seven IRS Tests for Material Participation
500+ Hours Test
You participated more than 500 hours in the activity during the tax year
Substantially All Test
Your participation was substantially all participation by any individual
100+ Hours, No One More Test
You participated 100+ hours and no other person participated more
Significant Participation Test
Combined hours in multiple significant participation activities exceed 500
Prior 5-of-10 Years Test
You materially participated in the activity for any 5 of the prior 10 years
Personal Service Activity Test
Activity is a personal service activity and you participated in any 3 prior years
Facts and Circumstances Test
Based on all facts, you participated regularly, continuously, and substantially
For most commercial real estate investors, Test 1 (500 hours per activity) and Test 7 (facts and circumstances) are the most commonly used.
The Grouping Election (Section 1.469-9(g)) is one of the most important planning tools for REPS taxpayers. Rather than proving material participation in each property separately, you elect to treat all rental activities as a single activity. Your total hours across all properties are combined, making it far easier to meet the 500-hour material participation threshold.
Attach a statement to your tax return for the first year you claim REPS, identifying the election and listing all grouped properties. Once made, this election is generally binding for future years. Work with your tax advisor on whether grouping is optimal, as it can affect gain calculations upon individual property sales.
If you own properties financed through permanent loans or acquisition loans, the depreciation becomes fully deductible against active income once you establish both REPS and material participation.
How Much Can REPS Save You in Taxes?
The tax savings from REPS depend on your income level, total depreciation deductions, and marginal tax rate. For high-income commercial real estate investors, the savings can reach six figures annually. The key mechanism is the ability to use depreciation, a non-cash expense, to reduce taxable income from wages, business profits, and other active sources.
Consider this example. An investor purchases a $5 million multifamily property with a $1 million land value and $4 million depreciable basis. Standard depreciation yields approximately $145,000 per year. A cost segregation study could push first-year depreciation to $800,000 or more through accelerated schedules and bonus depreciation.
Without REPS, that $800,000 loss is passive and can only offset passive income. With REPS and material participation, the full $800,000 offsets active income. At a 37% federal rate plus 3.8% NIIT and state taxes, the first-year savings can exceed $350,000. Over a 10-year hold, cumulative tax savings from REPS on a single property can surpass $500,000.
REPS Tax Savings: With vs. Without Qualification
| Tax Scenario | Without REPS | With REPS | Annual Savings |
|---|---|---|---|
| $150K depreciation loss usage | Suspended (passive) | Fully deductible | $55,500 to $70,000 |
| NIIT on $300K rental income | $11,400 tax owed | $0 tax owed | $11,400 |
| Cost seg Year 1 ($800K loss) | Suspended (passive) | Fully deductible | $296,000 to $370,000 |
| Passive loss carryforward | Accumulates unused | Not applicable | Immediate cash benefit |
| State tax treatment | Passive limitations apply | Non-passive in most states | Varies by state |
The net investment income tax (NIIT) of 3.8% is another area where REPS provides savings. Rental income earned by a qualifying real estate professional is excluded from NIIT, saving an additional 3.8% on all net rental income above the applicable threshold ($250,000 for married filing jointly). This is frequently overlooked but adds meaningful savings for high-income investors.
For investors building a portfolio of commercial properties financed through refinance programs or acquisition debt, each property adds to the total depreciation pool available to offset active income, compounding the REPS benefit year after year.
What Documentation Do You Need to Survive an Audit?
REPS is one of the most frequently audited tax positions by the IRS. The burden of proof falls entirely on the taxpayer, and the courts have consistently denied REPS claims where documentation was inadequate. A contemporaneous time log is the single most important piece of evidence you can maintain.
What "Contemporaneous" Means. The IRS expects records created at or near the time the work was performed. A spreadsheet reconstructed at year-end from memory receives far less weight than a daily log. Tax Court cases including Moss v. Commissioner and Almquist v. Commissioner have rejected REPS claims based on after-the-fact reconstruction.
Building an Audit-Proof REPS Documentation System
Choose a Tracking Method
Use a dedicated app (Toggl, Stessa, REI Hub) or a structured spreadsheet updated daily
Log Activities Daily
Record date, property, task description, and duration within 24 hours of completion
Save Supporting Evidence
Retain emails, texts, photos, receipts, mileage logs, and calendar entries
Reconcile Monthly
Review running totals against both the 750-hour and majority-of-time thresholds
File the Grouping Election
Attach the Section 1.469-9(g) election statement to your tax return if grouping
Annual CPA Review
Have your tax advisor review logs and supporting documents before filing
Essential Elements of a Time Log:
- Date of each activity
- Description of the specific task performed
- Property or activity the work relates to
- Duration in hours and minutes
- Running total of hours by activity and overall
Supporting Documentation to Retain:
- Emails and texts with tenants, contractors, and vendors (date-stamped)
- Phone records showing calls to property managers and service providers
- Calendar entries for property visits and meetings
- Mileage logs for trips to properties
- Receipts, contractor invoices, and payment records
- Lease agreements and bank statements showing real estate expenses
Digital Tools for Hour Tracking. Several apps designed for real estate professionals automate time tracking. REI Hub, Stessa, and general time-tracking tools like Toggl allow you to log hours on your phone immediately after completing tasks. The key is consistency. Logging activities daily takes 2 to 3 minutes and provides audit-grade documentation.
Common Audit Triggers:
- Claiming REPS while working full time in a non-real estate W-2 job
- Large passive losses relative to income
- Inconsistent reporting between spouses on joint returns
- Round-number hour estimates (e.g., exactly 750 hours)
- First year claiming REPS with a dramatic change in tax liability
Protect your tax position by maintaining thorough records from day one. The cost of proper documentation is negligible compared to the potential tax liability if your REPS claim is denied.
Can You Qualify for REPS With a Full-Time Job?
This is one of the most common questions about real estate professional tax status, and the answer depends entirely on the nature of your full-time job and total hours worked. The majority-of-time test requires that more than 50% of your personal services are in real property trades or businesses, creating a mathematical challenge for traditional W-2 employees.
Scenario 1: Full-Time Non-Real Estate Employee. If you work 2,080 hours per year (40 hours per week) at a non-real estate job, you need more than 2,080 hours in qualifying real estate activities. That totals over 4,160 working hours annually, roughly 80 hours per week. This is nearly impossible to sustain and document credibly.
Scenario 2: Part-Time Employee. Working 20 hours per week (1,040 annual hours) at a non-real estate job means you need more than 1,040 real estate hours. At 20 to 25 hours per week dedicated to real estate, this is achievable with multiple actively managed properties.
Scenario 3: Real Estate Industry Employee. If your W-2 employer is in a qualifying real property trade or business and you own more than 5% of the company, those hours count toward both tests, making qualification significantly easier.
Scenario 4: Spouse Qualification Strategy. For married couples filing jointly, only one spouse needs to qualify. One spouse manages real estate full time while the other maintains W-2 employment. The qualifying spouse's REPS status allows the couple to deduct rental losses against the employed spouse's income.
Consult with a tax professional before restructuring work arrangements. Use our DSCR calculator to evaluate whether property cash flows support a reduced W-2 income.
What Happens When REPS Interacts With Cost Segregation?
The combination of REPS and cost segregation is one of the most powerful tax strategies available to commercial real estate investors. Cost segregation accelerates depreciation by reclassifying building components into shorter recovery periods (5, 7, or 15 years instead of 39 years), and REPS allows those accelerated deductions to offset active income immediately.
With bonus depreciation at 40% for assets placed in service in 2026, a $10 million commercial property with $2.5 million in reclassified assets could generate a $1 million first-year deduction on top of standard depreciation. Without REPS, that loss is passive and suspended. With REPS and material participation, it directly reduces taxable active income. At a combined federal and state marginal rate of 45%, the immediate cash tax savings on this single property is $450,000.
This strategy is especially valuable for investors using acquisition financing to build portfolios. Each property generates additional accelerated depreciation that flows through to offset active income. Learn more about depreciation strategies for commercial real estate and how they integrate with REPS.
What Are the Most Common Mistakes That Disqualify REPS Claims?
The IRS and Tax Court have denied REPS claims in numerous cases, often due to avoidable mistakes. Understanding these common errors helps you structure your activities and documentation to withstand scrutiny.
Mistake 1: Insufficient or Reconstructed Time Logs. In Pohler v. Commissioner, the Tax Court denied REPS because the taxpayer's log was created after the audit began. Courts consistently reject after-the-fact estimates.
Mistake 2: Failing the Majority-of-Time Test. Many taxpayers focus only on the 750-hour requirement. If you work 1,800 hours at a non-real estate job, you need more than 1,800 hours in real estate. Simply meeting 750 hours is not sufficient.
Mistake 3: Double-Counting Hours. Non-qualifying activities cannot be relabeled as real estate work. A personal errand that includes a quick property check does not convert the entire trip into qualifying hours.
Mistake 4: Forgetting the Grouping Election. Without the election, you must prove material participation per property. Some properties may not independently meet the threshold.
Mistake 5: Counting a Spouse's Hours Incorrectly. One spouse's hours cannot be attributed to the other. The qualifying spouse must independently meet both tests using only their own hours.
Common REPS Mistakes and How to Avoid Them
| Mistake | Why It Fails | Prevention Strategy |
|---|---|---|
| Reconstructed time logs | Courts reject after-the-fact records | Log hours daily using an app or spreadsheet |
| Ignoring majority-of-time test | 750 hours alone is not enough | Track all personal service hours, not just RE |
| Double-counting hours | IRS disallows inflated or vague entries | Be specific about tasks and durations |
| Missing grouping election | Must prove participation per property | File election statement with your tax return |
| Counting spouse hours incorrectly | Each spouse must independently qualify | Maintain separate logs for each spouse |
| Round-number estimates | Signals estimation rather than tracking | Use precise time entries (e.g., 1.25 hours) |
Frequently Asked Questions About Real Estate Professional Tax Status?
What is the 750-hour rule for real estate professionals? You must spend more than 750 hours per tax year performing personal services in real property trades or businesses where you materially participate. This is one of two tests. You must also spend more than half your total working hours in real estate activities.
Can both spouses qualify as real estate professionals? Yes, but each spouse must independently meet the 750-hour and majority-of-time tests using their own hours. You cannot combine spousal hours to meet either threshold. However, for a married couple filing jointly, only one spouse needs to qualify for the couple to claim REPS benefits on their joint return.
Does rental income count as passive if I have REPS? No. Once you qualify as a real estate professional and demonstrate material participation in your rental activities, the rental income and losses are reclassified as non-passive. This means losses can offset active income such as wages and business profits, and income is excluded from the 3.8% net investment income tax.
What happens to suspended passive losses when I qualify for REPS? Passive losses from prior years that were suspended due to passive activity rules do not automatically become deductible when you first qualify for REPS. However, you can use the current year's non-passive rental losses to offset active income going forward. Suspended losses from prior years remain passive and are released upon disposition of the property.
Can a real estate agent automatically qualify for REPS? Not automatically, but agents have a significant advantage. Brokerage hours (listings, showings, negotiations) count toward both tests. A full-time agent easily meets both thresholds but must still demonstrate material participation in their own rental properties to deduct rental losses.
Is there a minimum number of properties required for REPS? No. The IRS does not require you to own a minimum number of properties. You can qualify with a single rental property as long as you meet the 750-hour test, the majority-of-time test, and material participation in that property. However, investors with multiple properties often find it easier to accumulate qualifying hours.
What is the grouping election and should I make it? The grouping election under Section 1.469-9(g) lets you treat all rental activities as a single activity for material participation purposes, combining hours across all properties. Most REPS taxpayers benefit from this election, but consult your tax advisor as it affects gain calculations upon individual property sales.
How does REPS affect state taxes? Most states conform to the federal REPS rules, meaning the non-passive treatment of rental losses applies for state income tax purposes as well. However, some states have their own passive activity limitations or do not fully conform to federal Section 469. California, New York, and New Jersey have specific provisions worth reviewing with a state tax specialist.
Ready to Maximize Your Tax Benefits?
Qualifying for real estate professional tax status can save you hundreds of thousands of dollars over the life of your investment portfolio. Pair REPS with strategic financing, cost segregation, and accelerated depreciation for maximum impact.
Schedule a free consultation to discuss how our commercial loan programs support tax-efficient real estate investing. Our team works with investors nationwide to structure acquisition loans, permanent financing, and refinance programs that align with your investment and tax planning goals.
Contact Clearhouse Lending today to get started.
Sources: IRS Publication 925, Passive Activity and At-Risk Rules; Internal Revenue Code Section 469(c)(7); Treasury Regulation 1.469-9; Tax Court rulings including Moss v. Commissioner (T.C. Memo 2012-85) and Pohler v. Commissioner (T.C. Memo 2018-172); Journal of Accountancy, "Real Estate Professional Status: Key Planning Considerations" (2024).