Jennifer and Paul Tessmer-Tuck used to owe a lot in taxes.
“Our single biggest expense every year was our state and federal taxes, for sure,” Jennifer, a physician at a major Minneapolis hospital, told Business Insider.
That changed when they started buying real estate. A unique IRS designation called real estate professional status, or REPS, can allow rental losses that are typically considered passive to offset active income, such as W-2 wages.
For married couples, only one spouse needs to qualify, and those losses can be used to offset both spouses’ incomes. That’s why some tax professionals and investors refer to this strategy as the “marital loophole.”
“For a married couple, if one person has the real estate professional status, then as a couple, we can count our real estate losses against my W-2 income, which is a big advantage for us as high-income earners,” Jennifer said. In their case, Paul is the spouse who qualifies for REPS.
How REPS works
Typically, rental real estate losses are considered passive and can only offset passive income. For example, if you work as an accountant and invest in rental properties on the side, losses from your real estate business can offset rental income — but not your accounting salary. In the eyes of the IRS, those are separate categories of income.
REPS can change that. If one spouse qualifies as a real estate professional and materially participates in the rental activity, rental losses may be used to offset active income, including W-2 or 1099 earnings.
To get the tax benefit, investors still need to show a loss. In real estate, it’s possible to generate positive cash flow while reporting a tax loss, thanks to deductions such as depreciation and expenses tied to repairs, renovations, and other property costs.
For the Tessmer-Tucks, who built a 16-property portfolio between 2020 and 2026, the tax benefits tied to REPS have been significant.
“If we can reduce the amount of money that we’re paying in state and federal taxes and generate some cash flow from our rentals, that really gives us a leg up financially,” Jennifer said.
Who qualifies for REPS?
You qualify for REPS based on how you spend your time. Two main requirements must be met:
- You must spend more than 750 hours a year on real estate activities.
- More than half of your total working hours must be in real estate.
For the Tessmer-Tucks, qualifying did require a major lifestyle adjustment: Paul, an elementary school teacher, cut back to part-time work.
“And then he dedicated the other half of his time to doing real estate renovations,” Jennifer said. That shaped their acquisition strategy: They looked for single-family homes that needed light rehab so Paul could log enough real estate hours. He does everything from installing bathroom vanities and cabinets to remodeling kitchens.
Letizia Alto and Kenji Asakura, both physicians who later scaled back their hospital work after building a large rental portfolio, said they used REPS to “zero out” their income taxes for seven years and accelerate their path to financial independence.
Asakura transitioned to part-time hospital work in 2015 so he could qualify for the status. Again, only one spouse needs to qualify, meaning Alto could continue working and deduct the real estate losses against her clinical income.
Documenting those hours is critical. CPA Kristel Espinosa told BI that REPS can be closely scrutinized by the IRS.
“You can have other jobs, but you just have to be able to show that to the IRS if ever audited that the real-estate business really is your main thing,” she said.
Read the original article on Business Insider
The post High-earning real estate investors are using ‘REPS’ to slash tax bills. Here’s who qualifies. appeared first on Business Insider.
