Changing passive income to non-passive.

You may not be a typical real estate professional, but a review of your annual real estate related work may show that the IRS considers you a real estate professional. With that recognition, your real estate rental activity becomes non-passive and you can reap tax benefits from the losses incurred.

Or perhaps you already work in the real estate industry and own rental property separately from your primary role?

If so, there's a chance that you could qualify your rental activity as non-passive income. As a rental real estate investor, you likely know that the IRS automatically considers income derived from these investments as passive income unless you are a real estate professional.

Since passive losses are limited by the IRS to passive income, passive status limits your ability to maximize your losses and minimize your taxes. However, if you are a real estate professional, that passive activity becomes active and passive loss limitations do not apply.

Just how the IRS defines a real estate professional is found in Section 468 (c) (7) of the tax code. Taxpayers can be considered real estate professionals if they work at least 750 hours annually in the real estate business, such as construction, rental or development work, and spend at least 50 percent of their time actively engaged in the real estate business.

For example, a taxpayer meets the 750 hours requirement and 50 percent test because they are involved in a construction business. Through an unrelated partnership, the taxpayer owns several rental buildings.

Even though construction work enables the taxpayer to meet the tests to be deemed a real estate professional by the IRS, the taxpayer can only qualify their rental property investment if they materially participate in the rental activity. To consider whether the taxpayer's participation is material, each rental property is treated as a separate activity. Thus, the taxpayer would need to spend a lot of time on each individual property to qualify as non-passive activity. That challenge presents a big hurdle to jump just to achieve non-passive status.

However, another option exists in the IRS code if used properly. A taxpayer can treat all of his rental activity as a single activity as permitted under Section 469(c) (7)(A)(ii).

Thus, if the taxpayer materially participates in a single rental property, all of their rental properties can qualify as non-passive activity.

Taxpayers who don't consider themselves real estate professionals, but spend their time working on investment properties should reconsider their status to gain non-passive recognition.

People who meet the 750 hour, 50 percent test for real estate professional by managing and maintaining their rental properties obviously meet the material participation requirement. For example, a retiree who owns multiple properties may spend 750 hours (approximately 14 1/2 hours per week) on the rental activity. Because the retiree no longer performs business services, the individual is spending all their time on real estate activity, far exceeding the 50 percent test.

Non-passive status is an especially important application for rental activities generating losses.

In order to consolidate your rental activity and be treated as a real estate professional, all you need to do is attach an election to your tax return.

Once the election is made, the IRS cannot revoke the real estate professional status in the future unless there is a relevant material change in the taxpayer's life. This will enable you to offset real estate losses against other income, such as wages, interest, dividends, etc., thereby minimizing your taxes.