We have dedicated quite a number of newsletters to house exchanges, buying and selling a house, HUDs, and home inspections. Each time we mentioned that help from professionals may be an essential part to your success in any kind of real estate endeavor.

Generally speaking, a real estate agent (sometimes called real estate salesperson) is an authorized intermediary between sellers and buyers of real estate.

We need a real estate agent to market our property and sell it for the highest possible price under the best terms, or to assist us in purchasing property for the lowest possible price under the best terms.

To be able to understand the market conditions and know the laws pertaining to real estate, all real estate agents are required to have some formal training and licensing. They are required to have at least a high school diploma, a minimum age of 18 or 21 (depending on the state), and real estate instruction ranging from 30 to 90 hours. Having met these requirements, the aspiring real estate agent must pass a written test to get a license. In most states, agents must renew their licenses every one to two years. Although there usually is no further examination requirement, most states require continuing education hours to renew the license.

If you ever wish to become a real estate agent then you should also know you must work under a licensed real estate broker.

You can apply at the various real estate agencies in your area to find a job. In some states, you have to be working with a broker before your license is valid.
Successful agents sometimes advance to broker and open their own offices.

Real estate brokers have to take a different, more comprehensive licensing exam. Usually, between 60 and 90 hours of classes are required for a broker's license, in addition to a number of years of experience working in the field. Some states require completion of eight college-level real estate classes for brokers. In some states, prospective brokers with a four-year degree in real estate can bypass the work requirement.

Lawyers may be allowed to handle real estate sales for compensation without being licensed as brokers or agents.

To be recognized as a realtor, the broker or agent must be a member of the National Association of Realtors (NAR) which implies taking yet another exam to get certified.

NAR's membership is composed of residential and commercial real estate brokers, real estate salespeople/agents, immovable property managers, appraisers, counselors, and others engaged in all aspects of the real estate (immovable property) industry, where a state license to practice is required.

They are pledged to a code of ethics and standards of practice, which includes duties to clients and customers, the public, and other Realtors.

Now, most people are, to some extent, familiar with all of the above, but do you know the definition of a real estate professional under the Internal Revenue Code?

You cannot count personal services you performed as an employee in real property trades or businesses unless you were a 5% owner of your employer. You were a 5% owner if you owned (or are considered to have owned) more than 5% of your employer's outstanding stock, outstanding voting stock, or capital or profits interest.

A real property trade or business is a trade or business that does any of the following with real property:

Why is all this important? Well, if you are not qualified as a real estate professional, then you are classified as passive real estate investor and are prohibited from deducting your job-related losses, including depreciation as well as office and travel expenses, in full.

Losses from passive activities can only be deducted against income from passive activities. One exception to this rule is that the first $25,000 of passive losses from rental activities can be deducted if you actively participated in the rental activities.

If you have more passive losses from real estate than you have passive income, your deduction of $25,000 will shrink as your AGI rises (see our newsletter on loss from real estate rental.) If you're subject to alternative minimum tax then this strategy won't work at all, because you can't write off these losses against AMT.

There is also an exception to the passive activity rules if you are a qualified real estate professional.

The extent of your material participation in the activity may be established by any reasonable means. The most reliable means of showing material participation consist of contemporaneously kept appointment books, calendars, daily time reports, logs, or similar documents that provide a detailed account of what you did with respect to an activity, when you did it, and how much time it took. Failure to substantiate material participation is one of the most common ways of losing the right to treat rental real estate activities as non-passive.

If you qualify as a real estate professional, the rental real estate activities in which you materially participated during the year can be classified as non-passive income or losses and used to offset ordinary income.

A real estate professional enjoys tax advantages not available to employees or individuals who only dabble in real estate investments.

As a real estate professional you can deduct any expense incurred for your real estate business, for example, the cost of advertising, small gifts, creating a website, and paying an assistant are all deductible expenses.

If you borrow money for your business, you can deduct the interest paid for the borrowed money. Your association dues are deductible along with any payments for any insurance. Other deductible real estate business expenses are bank service fees, business gifts, professional publications, legal fees, training, seminars, trade shows, postage, office supplies and any other real estate education expenses.

As a self-employed real estate professional, claiming your business expenses directly against your self-employment income on Schedule C instead of as a miscellaneous itemized deduction on Schedule A reduces your AGI and also ensures that you won't lose any of these deductions to the Alternative Minimum Tax.

Tax law allows a deduction for “depreciation” of rental real estate property. This is generally considered a non-cash deduction and contrary to economic reality, since the value of the structure generally goes up, not down, over time. For a cash-flow positive property, some or all of the net positive cash flow is not taxable in the year received, but instead many years later. Some experts call this “phantom income”. For a cash-flow negative property, depreciation results in deductions greater than cash paid each year for rental property expenses. This, of course, is called by some “phantom deductions”.

One of every seven taxpayers subject to the Alternative Minimum Tax is paying it, at least in part, because of a passive activity.

You should carefully consider all options before electing to be a real estate professional. The election can be made in any year that the rules apply.  However, once the election has been made, it cannot be reversed, unless there is a material change in your situation.

If you have multiple real estate interests and also are involved in another profession that requires a lot of time, then it might be impossible to meet the two requirements of eligibility.

So, before deciding to become a real estate professional for tax purposes, please consult a certified tax professional to make sure this option is advantageous to your particular case.