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Can Rental Losses Offset Ordinary Income?

Are you a real estate investor who also has a full-time job? Wouldn't it be amazing if you could reduce your wage income with rental losses? The good news is that in some cases, you...


Are you a real estate investor who also has a full-time job? Wouldn't it be amazing if you could reduce your wage income with rental losses? The good news is that in some cases, you can offset your ordinary income with rental losses. However, it's important to understand the qualifications and restrictions that apply. Let's explore how rental losses can be used to minimize your taxable income.

How Are Rental Losses Classified?

Rental income is generally considered passive income. Similarly, rental losses are passive if the rental property didn't generate any income and resulted in a loss. It's important to note that passive losses can only be used to offset passive income.

Active participation in the rental property can change the classification of the losses. If you are actively involved in managing the rental property, the losses can fall under a special allowance that allows them to offset your ordinary income. To qualify for this allowance, you must meet certain criteria.

First, you need to have active participation in the rental property. This means you must own at least 10% of the property and have made significant management decisions. These decisions can include approving new tenants, authorizing expenditures, making repairs, advertising the property, collecting rent, and determining rental terms.

It's important to note that you don't have to personally handle these tasks. You can hire a property management company to take care of them on your behalf. However, it's essential that the significant decisions are made by you as the investor, not by someone else running the business.

The second qualification is based on your income. If your MAGI (modified adjusted gross income) is below $100,000 (or below $50,000 if married filing separately), you can claim the full $25,000 deduction. The deduction begins to phase out for incomes between $100,000 and $150,000, and those with incomes above $150,000 do not qualify.

For example, let's say you qualify for the full $25,000 deduction and you earn $90,000 from your full-time job. After applying the deduction, your ordinary income is reduced to $65,000. This deduction can have a significant impact on your tax liability.

The rental loss is reported on Schedule E and goes on line 22. It originates from Form 8582 and flows through to line 26 of Schedule E.

What Happens to the Loss if You Don't Qualify?

If your income is too high, you don't own at least 10% of the property, or you aren't actively managing it, the rental loss doesn't disappear. It is still declared on Schedule E but doesn't flow down to line 26. Instead, it is held on Form 8582 until it can be used in the future.

There's a chance that your passive income will increase at a later date, allowing you to offset it with the previous rental loss. Additionally, if you sell the property, you can use the rental loss, including any losses from previous years, assuming they apply to the same property.

It's important to note that rental losses are categorized differently for real estate professionals (REPs). Rental losses for REPs are not considered passive and can be used to offset other income.

Please keep in mind that reporting rental losses on Form 8582 can be complex. It's highly recommended to work with a real estate accountant when filing tax returns involving rental properties.

Remember, understanding the rules surrounding rental losses can help you make the most of your investment and potentially reduce your tax liability. So, if you're a real estate investor with rental properties, make sure to explore the options available to you and consult with a knowledgeable professional.