Real estate investors often hear about the tax benefits of qualifying as a Real Estate Professional (REPS). When done correctly, REPS status can unlock significant deductions, allowing you to offset W2 income with passive real estate losses. But what happens if you claim REPS based on your CPA’s advice and then a state audit rejects your status?
This exact situation can be stressful and confusing. Below, we’ll break down your options, what you should consider before taking your next step, and how to protect yourself moving forward.
Understanding the REPS Rules
The IRS and state tax authorities both use strict criteria to determine whether someone qualifies as a Real Estate Professional. In general, two requirements must be met:
- More than 50% of personal services performed during the year must be in real estate trades or businesses in which you materially participate.
- At least 750 hours per year must be spent materially participating in those real estate activities.
If you have a full-time W2 job unrelated to real estate, state auditors often take the position that it’s nearly impossible for you to meet the “more than 50% of time” test—even if you’ve logged hours that suggest otherwise.
Option 1: Appeal the Audit Decision
If you truly have detailed logs, calendars, and other evidence of your real estate activities, you may be able to appeal the state’s decision. Strong documentation should include:
- Contemporaneous time logs (not recreated after the fact).
- Evidence of active participation (emails, contracts, invoices, property management activities).
- Proof that your real estate activities were substantial enough to outweigh your W2 hours.
Keep in mind: appeals can be costly and time-consuming, and success depends heavily on how convincing your evidence is relative to your W2 obligations.
Option 2: Amend Your Return
If your evidence isn’t strong—or if the cost of fighting outweighs the potential tax savings—you may decide it’s more practical to amend your return. By removing the REPS claim and paying the resulting tax, you can reduce penalties and interest, and avoid prolonging the dispute.
This option also helps you move forward with more certainty rather than spending months in appeals.
Option 3: Consider Recourse Against Your CPA
If your CPA assured you that you qualified for REPS but failed to account for the obvious limitation of your W2 job, you may have grounds for a professional negligence claim.
Your options could include:
- Requesting the CPA cover penalties and interest (many firms carry errors & omissions insurance for this).
- Filing a complaint with the state board of accountancy if the advice was clearly below professional standards.
- Consulting a legal professional to evaluate whether you have a malpractice case.
Before taking action, review your engagement letter with the CPA—some agreements limit liability.
Key Takeaways
- Appeal if your documentation is airtight. Logs and supporting evidence are crucial.
- Amend if your case is weak. It’s often better to pay and move on than risk larger penalties.
- Evaluate your CPA’s role. If their advice was clearly flawed, consider seeking reimbursement for costs tied to their mistake.
Final Thoughts
REPS status can be incredibly valuable, but it’s also one of the most heavily scrutinized tax positions. If you’re considering claiming it, work with a CPA who has deep experience in real estate taxation and who will evaluate your eligibility conservatively.
If you’re already facing an audit dispute, talk with both a tax attorney and a different CPA for a second opinion before deciding whether to appeal or amend. The right choice depends on the strength of your evidence, the size of the tax bill, and your tolerance for risk.