REPS, the 750-hour test, and §469 passive activity rules

What is real estate professional status (REPS) for tax purposes?

Real Estate Professional Status (REPS) is the IRC §469(c)(7) carve-out from the per-se-passive treatment that normally applies to rental activities. A taxpayer who qualifies as a real estate professional escapes the §469(c)(2) presumption — rental losses, including the large losses cost segregation often produces, can be non-passive and offset W-2, business, and portfolio income (subject to material participation in each rental). REPS has two prongs: the 750-hour test and the "more than half of personal services" test. Both must be met every year.

What's the 750-hour test?

Under IRC §469(c)(7)(B)(ii), a taxpayer qualifies as a real estate professional only if they perform more than 750 hours of services during the tax year in real property trades or businesses in which they materially participate. "Real property trades or businesses" are defined broadly in §469(c)(7)(C): development, construction, acquisition, conversion, rental, operation, management, leasing, or brokerage. Hours must be tracked contemporaneously — Moss v. Commissioner (T.C. Memo 2017-30) and many other Tax Court decisions have rejected reconstructed time logs prepared after the fact.

What's the "more than half of personal services" test?

The first prong of REPS, in IRC §469(c)(7)(B)(i): more than 50% of the personal services the taxpayer performs in all trades or businesses during the year must be in real property trades or businesses. A full-time W-2 employee working 2,000 hours at a non-real-estate job will struggle to meet this — they would need more than 2,000 real-estate hours. This is why REPS is hard for W-2 earners and easier for retirees, self-employed real estate operators, or non-working spouses.

Can my spouse qualify as a real-estate professional for me?

Yes, in the sense that on a joint return, if either spouse independently qualifies as a real estate professional under §469(c)(7), the rental activities are not per-se passive for the couple. However, material participation under §469(h) is determined by combining both spouses' participation under IRC §469(h)(5). So the qualifying spouse handles the REPS hour tests alone (no aggregation between spouses for the 750-hour and 50% tests per Treas. Reg. §1.469-9(c)(4)), and then either spouse's hours count for material participation in each rental activity.

What's material participation under §469?

Material participation is the threshold of involvement that makes activity income or loss non-passive. IRC §469(h) and Treas. Reg. §1.469-5T(a) list seven tests; meet any one and you materially participate. The most-used: (1) 500+ hours in the activity; (2) substantially all of the participation in the activity for the year; (3) 100+ hours and not less than any other individual; (4) significant participation activity totaling 500+ hours across all SPAs; (5) materially participated in 5 of the prior 10 years; (6) personal service activity prior 3 years; (7) facts and circumstances.

What happens to my cost-seg deduction if I'm not REPS?

For a long-term rental without REPS and without an STR carve-out, the cost-seg-generated loss is a passive activity loss (PAL) under IRC §469(d)(1). It cannot offset W-2 or portfolio income in the current year. It does not vanish — it suspends and carries forward indefinitely under IRC §469(b), available against (a) future passive income from any source, or (b) the gain on sale of the activity in a fully taxable disposition under IRC §469(g). So cost segregation on a non-REPS, non-STR rental is a deferral that crystallizes on disposition, not a current-year W-2 offset.

What's a passive activity loss carryforward?

A PAL carryforward is a suspended loss from a passive activity that exceeds passive income in the year it arose. Under IRC §469(b), the unused loss carries forward to future tax years and is allowed when the taxpayer has passive income to offset, or in full when the taxpayer disposes of the entire interest in the activity in a fully taxable transaction (IRC §469(g)(1)). Cost segregation on a non-REPS rental commonly generates a large Year-1 PAL carryforward; the deduction is preserved but the timing of the offset depends on either future passive income or sale.

Can I elect to aggregate all my rental activities under §469(c)(7)?

Yes. Treas. Reg. §1.469-9(g) allows a real estate professional to elect to treat all interests in rental real estate as a single activity for purposes of the §469 material participation tests. Without the election, REPS qualifiers must materially participate in each rental separately, which is often impossible for owners with many small rentals. The election is made by attaching a statement to the original return, is binding for all future years unless revoked under Rev. Proc. 2011-34, and applies only to the taxpayer who makes it.

Does cost segregation work for a high-W-2-income property owner?

It works as a deferral almost always; it works as a current-year offset against W-2 only in two scenarios: (1) the property is a short-term rental (average stay ≤ 7 days, Treas. Reg. §1.469-1T(e)(3)(ii)(A)) and the owner materially participates; or (2) the owner (or spouse on a joint return) qualifies as a real estate professional under §469(c)(7) and materially participates in the rental. Without one of those, the cost-seg loss is a PAL carryforward that suspends until passive income arises or the property is sold.

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