Rental real estate losses are passive by default. They can only offset passive income, not wages or business profit. Real estate professional status (REPS) is the statutory exception that converts those suspended losses into fully deductible ordinary losses. The OBBBA makes REPS more powerful and more complex.
The $25,000 Special Allowance (Non-REPS)
Before diving into REPS, know that active-participation landlords who don't qualify as real estate professionals can still deduct up to $25,000 of rental losses if MAGI is under $100,000. The allowance phases out between $100K–$150K at $0.50 per dollar. Above $150K, it's zero. For most high earners, REPS is the only path.
The Three Tests
Test 1, 750 Hours. You must log 750+ hours in qualifying real property trades or businesses: development, construction, acquisition, rental, operation, management, leasing, or brokerage.
Test 2, 50% of All Services. More than half of all your personal services during the year must be in qualifying real estate. If you work 2,000 hours at a non-real-estate job, you need 2,001+ in real estate. This is why full-time W-2 employees rarely qualify.
Test 3, Material Participation Per Rental. You must materially participate in each rental separately. There are seven tests under Temp. Reg. §1.469-5T, the most common being 500+ hours per activity, but you can also qualify by being the sole participant, logging 100+ hours (more than anyone else), or meeting certain historical participation patterns. Without the grouping election, meeting this per-property is the hardest part.
Joint return rule: Each spouse must independently meet Tests 1 and 2. Spouses cannot combine hours for the 750-hour or 50% tests. However, for Test 3 (material participation), spouses can aggregate hours.
The Grouping Election
Without grouping, an investor with five properties needs 500+ hours per property, which is nearly impossible. Under IRC §469(c)(7)(A), REPS taxpayers can elect to treat all rental interests as one activity. Hours across the entire portfolio combine, making material participation achievable.
The election is made by attaching a written statement to your return. It's generally binding for all future years, though Reg. §1.469-9(g)(1) allows revocation if there's a material change in facts and circumstances. No IRS approval needed to make the election.
How the OBBBA Changes the Math
The OBBBA permanently restored 100% bonus depreciation and permanently imposed the excess business loss (EBL) cap. Together, they reshape REPS planning:
More upside: A $1.5M rental with a cost segregation study might reclassify $250K–$350K to short-lived property, fully deductible in year one under bonus depreciation.
New ceiling: Even after clearing the passive activity rules, losses are capped at $313,000 (single) / $626,000 (MFJ) for 2025. Excess converts to NOL carryforwards (offsetting 80% of future income indefinitely, not lost, just deferred).
What the IRS Looks For in Audits
REPS is a top audit target. Key triggers:
- Full-time W-2 job in a non-real-estate field while claiming REPS
- Reconstructed time logs (courts consistently reject after-the-fact calendars)
- Round-number hour totals with no supporting detail
- Large Schedule E losses against six-figure W-2 income
- Failure to make the grouping election, then failing material participation property-by-property
- Post-OBBBA large K-1 losses from cost segregation studies
Start a contemporaneous time log now if you're planning to claim REPS for 2026. Track dates, locations, hours, and specific activities. A dedicated spreadsheet or app is essential.
Action Items
Before filing 2025: Confirm you met the 750-hour and 50% tests. Attach the grouping election statement if claiming for the first time. Prior-year suspended losses release in the first year you qualify.
For 2026: Begin logging hours immediately. Model whether projected losses will exceed the EBL threshold. If so, plan for NOL carryforward timing.
REPS qualification with cost segregation and the grouping election is the most powerful loss acceleration tool for individual taxpayers. But errors are among the most expensive audit adjustments the IRS pursues.
Contact TS CPA for REPS qualification analysis and passive loss planning.