Are you a real estate investor looking to offset your income for tax purposes? Understanding the real estate passive loss rules is crucial for maximizing deductions on your rental properties. Let's delve into the key concepts to help you make the most of your investment.
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 stipulate that passive losses can only be used to offset passive income. This means that these losses may be limited in their deductibility.
However, if you and your co-owners have passive income from other sources, the losses generated by the rental activity can be used to offset that income. It's important to note that if you don't have other passive income, the passive activity losses will be suspended and carried forward indefinitely. These losses can be utilized once you have passive income to offset them or when you dispose of the rental activity in a complete and taxable disposition.
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. This allowance of $25,000 is available to you and each of your co-owners. To actively participate, you must be involved in making key management decisions regarding the property, such as approving new tenants, rental terms, and capital expenditures.
However, this $25,000 special allowance is subject to a limitation. If your adjusted gross income (before passive losses) exceeds $100,000, the allowance is reduced by 50% of the amount by which your adjusted gross income exceeds $100,000. The allowance is completely phased out if your adjusted gross income exceeds $150,000. Keep this in mind while planning your tax strategy.
The Exception for Real Estate Professionals
Another special rule to consider is the exception for real estate professionals. Qualifying real estate professionals can 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 spend more than 750 hours during the tax year in real property trade or business as a material participant. Additionally, more than 50% of the services performed in all your businesses during the tax year should be in real property businesses where you materially participate.
According to Section 469(c)(7)(C), a "real property trade or business" encompasses activities such as real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental operation, management, leasing, or brokerage trade or business.
Get Expert Advice Today
Understanding the intricacies of real estate rental activity rules is essential for optimizing your tax planning strategies. If you want to take your deductions to the next level, reach out to our construction and real estate services team. Our seasoned experts can guide you through the process, ensuring you make the most of your rental properties.
By Judy Mondry, CPA, CVA (retired)
Remember, leveraging the real estate passive loss rules and investing in professional advice can make a significant difference in your tax liability. So, take advantage of these strategies and start saving more today!