WS1909 In And Outs of Becoming a Real Estate Professional | Kelsey Head

In today's episode , we continue our conversation with Kelsey Head, a seasoned CPA and partner at Head Tiler LLP. With 19 years of tax experience, Kelsey shared her insights on how real estate investors can navigate the complexities of tax benefits, particularly focusing on the coveted real estate professional status.

Kelsey emphasized that becoming a real estate professional can significantly impact an investor's ability to deduct passive losses and offset income. However, she pointed out that there are stringent requirements and common misconceptions to be aware of. For instance, full-time W-2 employees are unlikely to qualify as real estate professionals since more than 50% of their activities must be in real estate. Kelsey also highlighted the importance of documenting hours meticulously to meet the IRS's criteria.

We delved into strategies for restructuring employment to meet the qualifications, such as transitioning from W-2 to 1099 and reducing work hours. Kelsey also touched on the potential for spouses to qualify, thereby extending the benefits to both partners.

Listeners were cautioned against common pitfalls and misinformation, such as the misconception that holding a real estate license or working in mortgage lending automatically qualifies one as a real estate professional.

Kelsey's expertise was invaluable in shedding light on the nuances of achieving real estate professional status and the significant tax advantages it can offer. Her advice is a reminder of the importance of consulting with tax professionals to navigate the complex tax landscape in real estate investing.

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Transcript

Kelsey Head: We spend a lot of time as CPAs trying to not necessarily get around it, but reconfigure and reset up entities or set up a structure that makes sense because you may be doing exactly what we just said, but it was easier to continue to get a W-2 when all we have to do is switch you to a 1099, drop those hours. and do something else. And now we've turned around and we can deduct all of our losses, but we're making the exact same money we were before. Maybe more.

Whitney Sewell: This is your daily real estate syndication show. I'm your host, Whitney Sewell. Today, our guest is Kelsey Head. She's a partner at Head Tiler LLP, which she founded in 2020 during COVID after leaving a large firm. This is her 19th year in tax. I think she said to be approximately 18, 19 years of experience in tax as a CPA. She is going to dive into a series here with us. I hope you'll listen to each segment because we're going to dive into different questions that I get asked as an operator from our limited partners often. And so you're going to hear a number of things that I know you've had questions about. Kelsey, welcome. I'm honored to get this time with you to interview you and really go through some tax questions, right? Things that questions I know I get asked all the time. And often I have to say, Hey, I am not the one that question. All right. And so I have to look for obviously people like yourself, right, that are team members of ours, that we partner with, trusted experts like you that have those skill sets. And in your case, it's TACS, which we seem to, most of us need help in that world of TACS. So happy to get to chat with you today. Welcome. Thank you. Appreciate you having me. Kelsey, what about, you know, becoming that real estate professional? I remember when I was still working full time and trying to get into the space. And that was something I was like, man, I need to do that. I need to be able to figure that out. You know, but what does that mean, ultimately, for the for the passives that are listening that maybe don't even know about this? But, you know, is that something they should consider? And maybe what are some of the requirements? Let's dive into that.

Kelsey Head: Right. And there are There are a lot of requirements and a lot of nuances and a lot of, I would say gray area. Ultimately, if you can get to that real estate professional, all of the rules around passive losses and not being able to offset income and kind of hanging out there, all of that basically disappears with a real estate professional. So number one, and you just mentioned it at the very beginning, number one is, as long as you're a W-2 employee anywhere with a full-time salary, you're not a real estate professional. It just across the board, that's the first thing that just knocks you out. The reason for that is that in order to be a real estate professional, more than 50 percent of your activities have to be in qualifying real estate. So if you are working, I always use doctor as an example because they tend to be in real estate, but if I'm a doctor and I get a W-2, there's really no way the IRS is ever going to buy off on. I worked exactly 40 hours a week as a doctor and also 41 hours a week as a real estate professional. So I worked 80 hours a week year round without fail in order to hit that over 50%. So you're just you're give it up. It's not going to happen if you have a W-2 from an unrelated business. That's kind of number one. The second really, really big thing is you've got to document the hours. If it's very, very clear and you're an operator and you're the managing partner and all you do is GP interests and your whole life is wrapped in real estate, I think it's probably safe to assume that you're not going to have trouble with the hours. where I see it the most in every court case you look up on real estate professional, every time somebody has it taken away, it says no contemporaneous documentation of real estate professional. And so inevitably, the IRS comes in and they say, give us your proof. And someone hands them a handwritten 10 sheets of paper with gibberish on it that they've come up with during the audit. So you've got to have someone or yourself tracking your hours, what you're doing, what property it pertains to, you know, basically document your whole life because you are getting a huge benefit for being that and things that qualify You know, think about developing properties, construction, acquisition, rental properties, the actual day to day management of properties. What it doesn't include is I went out and I'm looking for a new investment in an LP. And so I looked at some offering documents, things like that don't qualify. And in order to be where we talked about active participation is 500 hours, real estate professional is 750 hours. So it bumps up another level. And it's even a higher threshold to hit. Because again, it's a huge benefit when you get there. And so one of the big things we see is, as people come up in the real estate profession, they'll, you know, start with maybe a GP somewhere, they might have, you know, five or six LPs already. But they're still working that full-time job. What you'll start to see is people try to cut, you know, to 50% time in their W-2 job. Maybe they're retiring or slowly retiring, or maybe they are getting off into real estate. That's when that documentation becomes super important is getting that over 50%. It can be done with a W-2 job, but you've got to be part-time or less is how I always look at it. So those are some of the big overarching rules up front that I see most often and tell people that's kind of step one is quit your day job. That's kind of number one.

Whitney Sewell: Yeah, no, that's helpful to think through. And it may even pay you a little more to go part-time if you can get the deductions and things, right? And maybe that's where you need somebody like yourself, right? We're going to talk about that in a bit, but you need somebody to help you think through that, right? Or maybe your specific tax implications of what that would look like, right?

Kelsey Head: Right. It really is, because I'll give you a good example. Say you are a part-time employee or say you're full-time to start with. You're full-time and you work for a real estate company. I see this a lot. You work as an asset manager or whatever title within a real estate company. But if you don't own 5% of that company, none of those hours qualify. And so what we've been doing a lot of recently is, okay, maybe, maybe you cut those hours that are directly, you know, given to that company, maybe it's 20 hours a week, because then I now can easily say I work over 40 hours a week and get there if I have enough qualifying activities. And we say, you know, okay, I'm going to go set up a company of my own, that's going to gather my acquisition fees on my first GP deal or it's going to gather management fees because I'm an asset manager and I'm doing this on the side but now I'm no longer an employee of that of that main business. I now have my own business and they pay me as a contractor. So we spend a lot of time as CPAs trying to not necessarily get around it, but reconfigure and reset up entities or set up a structure that makes sense because you may be doing exactly what we just said, but it was easier to continue to get a W-2 when all we have to do is switch you to a 1099, drop those hours and do something else. And now we've turned around and we can deduct all of our losses, but we're making the exact same money we were before.

Whitney Sewell: Maybe, maybe more, maybe more. I just hope the listeners hear that. Like you may be making more if you cut your hours back on your, on your W2. Right. Uh, you know, another, another thing I've seen people do Kelsey is, is, uh, and, and track this down. If this is not a good suggestion, by the way. Uh, but, but it's like their spouse become the real estate professional or your other spouse get involved in real estate. Right. Is that a liable option?

Kelsey Head: It does. It's for the real estate professional. If one spouse makes it, the other spouse gets the benefit. So if your wife is managing properties, LP, has some GP interests, a couple of Airbnbs, enough that their hours are significant, that meeting the 750, meeting all of the documentation requirements, then your LP investments And I should mention, too, that there are some grouping rules in here where we have to kind of group things together to make this work. But that's where we can come in handy, is making the proper elections and tax things that make it all work. But essentially, yes, one spouse can help cover the other spouse.

Whitney Sewell: Yeah, that again, that's why we need a professional like yourself to help us think through those options. Right. I think we're going to get into that. Uh, anything else around, you know, around this, uh, you know, the real estate professional status Kelsey, that maybe you get questions about, or the listener needs to know about.

Kelsey Head: Yeah. The only thing I'll say is I, again, I think there's a lot of, a lot of misinformation out there. on what will get you qualified. I've heard a couple lately that have concerned me a little bit as to where some of these are coming from and just making sure people are really aware and digging in a little further. And one of them was, well, I'll get my real estate license and I'll sell a couple of houses and that makes me a real estate professional so I can deduct everything else. Well, Probably not. Maybe if you have rental houses and all of the things that get you to that level, but a real estate license in and of itself doesn't help you unless all the other things follow. That's one that's come up multiple times lately. And then the other one that I've heard a couple of times just recently was, some lenders that are out there, they're mortgage brokers, but it's all commercial real estate loans. Somehow it had become a little bit of rumor that that was real estate specific. And that if you drop to a 1099 and basically the scenario I just gave you, but your job was in that real estate brokerage firm, that that somehow gave you the hours. there are specific cases that throw out lending. So nothing to do with mortgage lending can ever be real estate professional hours. Luckily, there are specific cases, so we don't have to question whether it's gray area or not. The IRS is fairly specific. If you can Google enough and use the research that's available, you can usually get to it if you keep digging a little further.

Whitney Sewell: Thank you for being with us again today. I hope that you have learned a lot from the show. Don't forget to like and subscribe. I hope you're telling your friends about the Real Estate Syndication Show and how they can also build wealth in real estate. You can also go to lifebridgecapital.com and start investing today.