Unlocking Losses: The Real Estate Professional Status (REPS) Test Explained
If you own rentals, hear about 100% bonus depreciation, and also have a big W-2 paycheck, you may be wondering:
“Why are my rental losses trapped as passive while my tax bill on my salary barely moves?”
The short answer: for most long-term rentals, the IRS treats your income and loss as passive by default. And passive losses generally cannot offset your W-2 income unless you qualify as a real estate professional and materially participate in the activity under IRC §469.
With the One Big Beautiful Bill Act (OBBBA) permanently restoring 100% bonus depreciation for qualifying property acquired and placed in service after January 19, 2025, those paper losses can be very large very quickly. That is fantastic news—if your rentals are non-passive. Otherwise, those losses simply pile up on Form 8582 as carry-forwards.
In this post, I will walk you through:
The difference between passive, active, and material participation
The exact Real Estate Professional Status (REPS) tests under IRC §469(c)(7)
How REPS, material participation, and 100% bonus depreciation interact
A numeric example showing the tax impact with and without REPS
Common mistakes that get REPS claims disallowed
Practical steps to use a REPS Hours Tracker to stay audit-ready
1. Why passive vs. non-passive matters more than ever in 2026
1.1 OBBBA and 100% bonus depreciation
Under OBBBA, 100% bonus depreciation under IRC §168(k) is now permanently available for qualified property acquired and placed in service after January 19, 2025. That includes many components identified in a cost segregation study on residential and commercial rental property—think appliances, flooring, certain land improvements, and interior finishes.
Result: it is routine to see six-figure first-year depreciation deductions on a new or renovated rental.
However, those deductions do not automatically reduce your W-2 income. By default, rental real estate is a passive activity, and passive losses are only deductible against passive income unless an exception applies.
1.2 Federal vs. Virginia (and other state) treatment
Because The RVA Accountant is based in Richmond, we also have to remember that Virginia does not conform to federal bonus depreciation under §168(k). Virginia requires you to add back federal bonus depreciation and then recapture additional depreciation in later years through state-specific modifications.
So:
Federal: 100% bonus can create large losses in year 1.
Virginia: You may not get the same front-loaded benefit; the state often spreads deductions over time.
That makes it even more important to decide whether those federal losses will actually reduce your W-2 income—or just sit as passive carry-forwards.
2. Passive, active, and material participation – in plain English
2.1 Passive activity rules (IRC §469)
Under IRC §469:
A passive activity is a trade or business or rental activity in which you do not materially participate.
Rental activities are generally passive even if you are heavily involved—unless you qualify as a real estate professional or the rental is short-term under specific rules.
The passive loss rules:
Allow passive losses to offset only passive income (and certain gains), and
Carry any excess passive losses forward until you have passive income or dispose of the activity in a taxable transaction.
2.2 “Active participation” and the $25,000 special allowance
There is a separate concept called active participation in rental real estate. If you actively participate (approve tenants, set rents, approve major repairs) and own at least 10% of the property, you may deduct up to $25,000 of rental real estate losses against non-passive income.
However:
The $25,000 allowance starts to phase out when your modified AGI exceeds $100,000 and is fully phased out at $150,000.
If you are in the $500k+ income world, you almost never get this benefit.
For our target audience, the $25,000 active-participation allowance is effectively off the table. That leaves two main paths to make rental losses usable against W-2 income:
Qualify as a Real Estate Professional under §469(c)(7) and materially participate in the rental, or
Structure certain short-term rental activities so they are not “rental activities” under §469 and then meet the general material participation tests.
This article focuses on path #1: Real Estate Professional Status.
3. The Real Estate Professional Status (REPS) tests
REPS is defined in IRC §469(c)(7) and further interpreted in regulations, IRS publications, and case law.
To qualify as a real estate professional for a tax year, you must meet both of these tests:
More than half of your personal services in all trades or businesses during the year must be performed in real property trades or businesses in which you materially participate; and
You must perform more than 750 hours of services during the year in those real property trades or businesses in which you materially participate.
Key details:
Real property trades or businesses include development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, and brokerage of real property.
On a joint return, either spouse must independently satisfy both tests using their own personal service hours. You cannot combine spouses’ hours to reach 750 or the “more-than-half” test
However, once one spouse qualifies as a real estate professional, both spouses benefit from having rental losses treated as non-passive on a joint return, provided material participation is also met at the activity level.
3.1 What “materially participate” means in this context
The REPS tests talk about real property trades or businesses in which you materially participate. The material participation standard is defined in §469(h) and Reg. §1.469-5T.
Most taxpayers rely on one of these common tests:
500-hour test: You participate in the activity for more than 500 hours during the year.
Substantially all test: Your participation constitutes substantially all of the participation in the activity by all individuals (including non-owners).
100-hour + more than anyone else test: You participate for more than 100 hours, and no one else (including property managers or contractors) participates more than you.
Hours can include:
Tenant communications and screening
Arranging for repairs and maintenance
Bookkeeping, paying bills, budgeting, and project management
Travel directly related to the activity
They usually do not include:
Pure investor-level activities (reading generic real estate news, “looking at Zillow” with no specific deal)
Time that is obviously inflated or unrealistic (for example, reporting dozens of hours to change a toilet). Courts have repeatedly thrown out REPS claims when logs were reconstructed or not credible.
For material participation in a specific activity, spouses’ hours are combined. Even if only one spouse is trying to qualify as a real estate professional, both spouses’ participation counts toward the material participation tests.
4. Turning REPS into real deductions: activity-level rules
REPS by itself does not automatically convert all of your rental loss into a deduction against W-2 income. Two extra steps are critical:
The rental must be treated as a trade or business in which you materially participate; and
You must meet the activity-level rules for your rentals.
4.1 By default, each rental is a separate activity
Under the passive activity rules, each rental property is treated as a separate activity unless you make an election to treat all interests in rental real estate as one activity.
That means:
Without any election, you would need to materially participate in each individual rental to make each loss non-passive.
For investors with multiple properties, that is often unrealistic.
4.2 The REPS grouping election (Reg. §1.469-9(g))
Real estate professionals can elect under Reg. §1.469-9(g) to treat all interests in rental real estate as a single activity solely for purposes of determining material participation.
Practical impact:
Your hours across all long-term rentals are pooled.
If you meet a material participation test on the grouped activity, all rentals in the group are treated as non-passive (again, subject to the excess business loss limit discussed later).
This election is generally made by filing an appropriate statement with your tax return and is intended to be binding for future years unless there is a material change in circumstances and you obtain IRS consent to regroup.
5. What about short-term rentals?
Short-term rentals—frequently Airbnb or VRBO properties—often fall outside the definition of “rental activity” if the average period of customer use is:
7 days or less, or
30 days or less and you provide significant personal services.
In those cases:
The activity may be treated as a non-rental trade or business, and
You may be able to avoid the REPS tests entirely and simply meet the general material participation tests to have losses treated as non-passive.
However, short-term rental structuring is nuanced, and the IRS has scrutinized these arrangements. If your objective is to use short-term rentals to offset W-2 income, we should look carefully at usage patterns, services provided, and documentation.
6. The excess business loss (EBL) speed bump
Even if you successfully:
Qualify as a real estate professional, and
Materially participate in your rentals,
your ability to use losses may still be capped by the excess business loss rules under §461(l). OBBBA extended these rules through at least 2028 and sets inflation-adjusted thresholds (for 2025, $313,000 single / $626,000 joint, indexed for 2026).
Any losses above the EBL threshold become net operating losses carried forward to future years instead of wiping out all current W-2 income. This is still valuable, but it tempers the idea of “unlimited” rental loss offsets.
7. Numeric example: REPS vs. non-REPS
Let’s look at a simplified 2026 scenario for a married couple filing jointly.
Facts
Spouse A: W-2 physician earning $600,000.
Spouse B: Focused on real estate full-time.
They acquire a small apartment building in 2026:
Purchase price: $1,500,000
Land value: $300,000 (non-depreciable)
Building/improvements: $1,200,000
They complete a cost segregation study that identifies $360,000 of 5-, 7-, and 15-year property eligible for 100% bonus depreciation under §168(k), plus $40,000 of current-year repairs.
Net rental economics for year 1 (before depreciation):
Rental income: $150,000
Operating expenses (taxes, insurance, utilities, management, etc.): $90,000
Net operating income (NOI): $60,000
Federal depreciation and net loss
Bonus depreciation: $360,000
Straight-line building depreciation (27.5-year): $1,200,000 ÷ 27.5 ≈ $43,600
Total depreciation: ≈ $403,600
Net rental result:
NOI: $60,000
Less total depreciation: (403,600)
Rental loss: ≈ $343,600
Now compare two situations.
Scenario 1: No REPS – losses are passive
Spouse B does not meet REPS or material participation (for example, they have another non-real-estate full-time job, and can only document 200 hours on the property).
The $343,600 rental loss is passive.
Spouse A’s $600,000 W-2 income is unaffected.
The loss carries forward on Form 8582 until they have passive income (for example, future rental profits or gains on sale), or until they fully dispose of the property.
They might still benefit from the $25,000 special allowance if their AGI were low enough—but at a $600,000 income level, the special allowance is fully phased out.
Result: no immediate tax reduction from the bonus depreciation.
Scenario 2: Spouse B qualifies for REPS and they make the grouping election
Now assume:
Spouse B spends 1,200 hours during 2026 in real property trades or businesses (managing this building plus one other), and
Total personal service hours for Spouse B across all work are 1,800 hours.
Spouse B:
Spends more than 50% of their working time in real property trades or businesses in which they materially participate, and
Exceeds the 750-hour requirement.
Spouse B qualifies as a real estate professional under §469(c)(7).
They also:
Make the Reg. §1.469-9(g) election to treat all rental real estate as one activity, and
Can document that, together with Spouse A, they meet a material participation test on that grouped rental activity (for example, more than 500 hours of combined participation).
Result at the federal level:
The $343,600 rental loss becomes non-passive.
It can offset Spouse A’s $600,000 W-2 income, subject to the excess business loss cap. Suppose the EBL threshold for MFJ in 2026 is approximately in the mid-$600k range (we will know the exact inflation-adjusted number each fall). If their aggregate business losses (including this rental) exceed that threshold, the excess becomes an NOL carry-forward.
Even with EBL limitations, it is realistic that they could reduce current-year taxable income by several hundred thousand dollars, plus shift the remaining loss into a future NOL.
That is the power of combining 100% bonus depreciation with properly documented Real Estate Professional Status and material participation.
8. Implementation checklist: building an audit-proof REPS strategy
Here is a practical, step-by-step framework we use when we walk clients through REPS planning.
Step 1: Clarify your “who” and “why”
Which spouse (or partner) is realistically in a position to meet the REPS tests?
How many hours do they already spend in their non-real-estate work?
How much tax savings do you expect to unlock if REPS succeeds (for example, projected bonus depreciation and losses)?
If one spouse has a heavy W-2 workload (2,000+ hours), it is very hard to credibly claim they spent more time on real estate than on that job, and courts have been skeptical of such claims.
Step 2: Inventory your real estate trades or businesses
List each activity separately:
Long-term rentals (by property)
Short-term rentals
Development or flips
Real estate brokerage or management companies
For each, note:
Ownership percentage
Type of entity (individual, LLC, partnership, S-corp)
Whether you are involved in day-to-day operations or rely on property managers
This classification drives which hours count toward REPS and which activities can be grouped.
Step 3: Decide whether a REPS grouping election makes sense
With multiple rentals, the Reg. §1.469-9(g) election to treat all rental real estate as a single activity is often critical.
Questions to consider:
Do you have enough combined hours across the portfolio to clearly meet a material participation test?
Are there any properties you might want to dispose of separately soon (remember that grouping can affect how suspended losses are freed on sale)?
Are there short-term rentals that should not be grouped because they are not “rental activities” for §469 purposes?
Step 4: Track hours with a REPS Hours Tracker (contemporaneously)
You need credible, detailed time records, not estimates created at year-end.
A good REPS Hours Tracker should capture:
Date
Property or activity
Description of the task (e.g., “Screened applicants for 123 Main St., responded to maintenance requests”)
Hours spent
Whether the time is real property trade or business work vs. investor-level research
You can track this in a spreadsheet, or a time-tracking app—we recommend something you will actually use every week.
The key is consistency and realism: the total hours should line up with your other commitments (W-2 job, family obligations, etc.), and descriptions should make sense if an IRS agent reads them.
Step 5: Run projections during the year
Before you commit to 100% bonus depreciation and REPS, we like to model:
Expected rental losses (with and without cost segregation)
Whether the REPS and material participation tests are on track to be met
The impact of excess business loss limits
Federal vs. Virginia tax effects, given Virginia’s nonconformity to §168(k) bonus depreciation
This mid-year check often informs whether it is worth pushing to hit the 750-hour/majority-of-services hurdle.
Step 6: File elections and keep documentation with the return
If you:
Qualify as a real estate professional, and
Intend to group all rental real estate activities,
we will include the proper grouping election statement with your timely filed return and keep a copy of your REPS hours tracker and supporting documentation with our workpapers.
9. Common mistakes and how to avoid them
Here are pitfalls I see often when reviewing REPS claims.
Trying to qualify while holding a full-time, non-real-estate W-2 job
If you work ~2,000 hours a year as a physician, attorney, or engineer, the IRS and the courts will scrutinize any claim that you spent even more time on your rentals.
Fix: Consider having the other spouse pursue REPS, or focus instead on short-term rentals and general material participation.
Counting investor-level or vague “education” time as hours
Time spent scrolling listings, attending general seminars, or reading books about real estate usually does not count toward material participation.
Fix: Only count time directly tied to your specific properties or real estate business operations.
Relying on reconstructed or unrealistic logs
Logs prepared after the fact, especially with round numbers or implausible times, are frequently rejected. Courts have disallowed REPS in cases where taxpayers claimed hundreds of hours for tasks that clearly should have taken far less time.
Fix: Track hours contemporaneously and write short, specific descriptions.
Assuming both spouses’ hours can be combined to meet the REPS tests
For the 750-hour and “more-than-half” tests, one spouse must meet both tests individually; you cannot add hours together.
Fix: Decide which spouse is the REPS candidate and track that spouse’s hours separately, while still pooling hours for material participation tests.
Failing to make the grouping election
Without grouping, each rental is a separate activity—you may miss material participation on several properties even if you work very hard across the portfolio.
Fix: If you qualify as a real estate professional, strongly consider the §1.469-9(g) grouping election and understand its long-term implications.
Ignoring the excess business loss rules
Even perfect REPS planning cannot avoid §461(l); very large losses may still be capped in the current year.
Fix: Model EBL impacts before you invest or accelerate depreciation so you have realistic expectations.
Assuming state rules match federal rules
As noted, Virginia and many other states decouple from federal bonus depreciation and may have different passive loss treatment.
Fix: Always check your specific state’s conformity and plan accordingly.
10. FAQ: Real Estate Professional Status in practice
Q1: Can my spouse qualify as a real estate professional while I keep my high-income W-2 job?
Often yes. On a joint return, only one spouse has to meet the REPS tests individually; if that spouse also materially participates in the grouped rentals, the rental losses can be non-passive for the couple.
This is a very common structure: one spouse has a demanding W-2 role, the other builds a real estate business and tracks their hours to qualify for REPS.
Q2: Do I have to be a licensed real estate agent or broker to qualify?
No. The definition of “real property trade or business” is broad and includes development, construction, acquisition, rental, operation, management, leasing, and brokerage. There is no licensing requirement in the statute.
However, work you perform as an employee of someone else’s real estate business generally only counts if you own more than 5% of that employer.
Q3: Can I qualify for REPS with just one or two rentals?
Possibly, but you need enough hours to:
Clearly exceed 750 hours, and
Make those hours more than 50% of your total personal services.
For many high-income professionals with a full-time non-real-estate job, it is difficult to credibly meet the “more-than-half” test with only a couple of rentals.
Q4: Do short-term rentals count toward REPS hours?
Hours in short-term rental activities (average stay 7 days or less or 30 days or less with significant services) can qualify as real property trades or businesses for REPS, but the activities themselves are not “rental activities” for the passive loss rules.
That means:
They may become non-passive with material participation alone (without REPS), and
You need to be careful not to double-count or misclassify hours.
Q5: Once I qualify for REPS in one year, am I “grandfathered” forever?
No. REPS is determined year by year. You must satisfy the tests each tax year you want to treat your rental losses as non-passive. Changes in your job, portfolio, or hours can cause you to lose REPS in a later year.
Q6: How does this interact with cost segregation studies?
Cost segregation studies identify components of a building that qualify for shorter recovery periods and, after OBBBA, 100% bonus depreciation.
Federal planning sequence typically looks like:
Evaluate whether REPS and material participation are realistically achievable.
If yes, consider a cost segregation study to front-load deductions into the years when you expect to qualify.
Model the effect of EBL and state decoupling.
Done correctly, REPS + cost seg + 100% bonus is one of the most powerful tax strategies for high-income households under the 2026 OBBBA regime.
11. Next steps: Use the REPS Hours Tracker and get a tailored plan
If you’re serious about using your real estate to offset W-2 income, here is what I recommend:
Download the REPS Hours Tracker Template
Start logging your time now, even if you’re mid-year.
Clean, contemporaneous records are your best defense in an IRS exam.
Schedule a REPS & Bonus Depreciation Planning Session
We will map your current work and real estate activities to the REPS and material participation tests.
We will model whether cost segregation and 100% bonus depreciation make sense given your federal and Virginia situation.
Integrate REPS into your overall tax plan
Coordinate REPS with retirement plans, business income, and potential liquidity events.
Avoid surprises from excess business loss limitations and state-level adjustments.
If you want help building an audit-ready REPS strategy around your portfolio, book a planning call with The RVA Accountant so we can look at your specific numbers.
Disclaimer: This article is for educational purposes only and does not constitute tax, legal, or accounting advice. The rules summarized here are general and may not apply to your specific situation. Tax outcomes depend on your full fact pattern, other income, and state law. You should consult with your own tax advisor before implementing any strategy discussed here.