Owning rental property may yield large financial gains in healthy markets. Recently, however, fluctuations in the real estate and housing markets have produced conditions which can lead to great financial losses. Because owning real estate is considered a “passive activity” by the tax code, there are certain restrictions and limitations regarding the amount of loss a taxpayer can claim in a taxable year. Some losses may have to be carried into future years and this carrying over might not result in the ideal financial situation for the taxpayer in the year he/she might need it most.
Internal Revenue Code section 469: Passive Activity Losses
In general, loss or credit from passive activities must be carried over to the next taxable year. The Internal Revenue Code (IRC) specifies rental activity as being included in the term passive activity, even if a taxpayer materially participates in the rental activity. However, IRC section 469 does allow a certain dollar amount of losses or credits to be claimed for rental real estate activities. A natural person can claim up to $25,000 of loss or credit in a taxable year if such loss or credit is attributable to all rental real estate activity in which the individual actively participated in such taxable year. But if a taxpayer’s adjusted gross income (AGI) is more than $100,000, then the allowance slowly phases out, reducing the $25,000 by 50% of whatever amount exceeds the $100,000 (not to go below zero). For example:
| AGI | Reduction | Allowable Loss or Credit | |
| Taxpayer A | $110,000 | 50% of 10,000 = 5,000 | $20,000 |
| Taxpayer B | $142,000 | 50% of 42,000 = 21,000 | $4,000 |
| Taxpayer C | $150,000 | 50% of 50,000 = 25,000 | $0 |
For anyone with an AGI over $150,000, the $25,000 offset in the IRC is eliminated. Fortunately, a taxpayer may be able to gain unlimited loss deductions if they or their spouse (if filing jointly) qualify as a real estate professional under IRC section 469.
Real Estate Professionals
An owner of rental real estate may qualify as a real estate professional and thereby not have his or her rental activity considered a passive activity. To qualify, more than one half of the real estate professional taxpayer’s or spouses’ personal services and more than 750 hours per year must be performed in real property trades or businesses in which the real estate professional taxpayer materially participates. This includes management, operation, construction and almost everything related to the real estate business. Regular, continuous, and substantial activity is considered “material.” The one-half/750-hour test is applied to each interest unless the taxpayer elected to treat all rental real estate interests as one. This is a very important election and must be properly executed.
This unlimited loss deduction for real estate professionals may bring substantial monetary benefit to property owners. Contact our tax law firm to determine if you currently qualify or if you can make changes that will enable you to take advantage of the tax code which can result in a very significant reduction in your taxes.
We represent many individuals and businesses from many industries, including but not limited to, real estate management, construction, professional service firms, medical practices, manufacturing, retail, technology development, etc. We provide comprehensive tax litigation, planning, and defense representation. We invite you to contact our law firm to discuss your legal questions. Please feel free to use our contact form or phone us at (415) 394-7200.