Real Estate Passive Loss Rules: Are Losses Deductible?

How Real Estate Losses Can Help Offset Your Income For Tax Purposes

Real estate rental activity income or loss is considered passive activity income or loss.

The passive activity loss rules provide that passive losses can only be used to offset passive income. Consequently, those losses may be limited.

If you and your co-owners have passive income from other sources, the losses generated by the rental activity may be used to offset that income. However, if you do not have other passive income, the passive activity losses will be suspended and carried forward indefinitely until either you have passive income to offset the suspended losses, or you dispose of the rental activity in a complete and taxable disposition.

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From The Real Estate Rental Activity Rule Book

A special rule allows taxpayers who “actively participate” in a rental activity to deduct up to $25,000 of loss from the activity each year regardless of the passive activity loss rules. The $25,000 allowance is available to you and each of your co-owners. You or your co-owners will be considered to actively participate in the rental activity if you make the key management decisions regarding the property. Examples of what would constitute active participation include approving new tenants, deciding on rental terms, and approving capital or repair expenditures. The $25,000 special allowance is, however, subject to a limitation. The $25,000 amount is reduced if you have an adjusted gross income (before passive losses) in excess of $100,000. The allowance is reduced by 50 percent of the amount by which your adjusted gross income exceeds $100,000. Consequently, the allowance is completely phased out if your adjusted gross income exceeds $150,000. If you or your co-owners have rehabilitation or low-income housing credits, a special rule allows the credits to offset tax on the nonpassive income of up to $25,000, regardless of the limitation based on adjusted gross income.

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Another special rule for which you or your co-owners may qualify is the exception for real estate professionals. This provision allows qualifying real estate professionals to deduct losses from rental real estate activities as nonpassive losses if they materially participate in the activity. To qualify as a real estate professional, you must demonstrate that you spend more than 750 hours during the tax year in real property trade or business in which you are a material participant. In addition, you must demonstrate that more than 50% of the services you perform in all your businesses during the tax year are performed in real property businesses in which you materially participate.

Section 469(c)(7)(C) defines the term “real property trade or business” as “any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental operation, management, leasing, or brokerage trade or business.”

If you would like to learn more about the real estate rental activity rules and how to take your tax planning strategies to the next level, give us a call or email the construction and real estate services team today.

By Judy Mondry, CPA, CVA (Cleveland office)

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