Unlimited tax deductions back in the days...

[Franklin Lee]

I heard from my dad that back 15 years ago when he was an active investor managing a rental business, he was allowed to take unlimited tax deductions...is this true?

Now, I know that you can only deduct up to 25,000, which can be a shame because I would like to manage more than 10 when I graduate from college. Now you can only manage 5 with the aid of the 25,000 passive losses limit.

One more thing...there is such things as being an active investor, passive investor, and real estate professional.

According to my knowledge, I believe that in order to be an active investor, you have to actively manage your properties thus giving you unlimited tax deductions. This is what I've heard from my parents. Please correct me if I'm wrong. I would like to be right though because this information would likely benefit the alter ego of mine - the landlord.

[Jon Holdman]

Be aware there are different categorizations for investors in the IRS rulebook. An "active" investor is not the same as a "real estate professional". To be a professional, and be able to take unlimited passive losses, you must spend at least 750 hours a year doing real estate activities AND you must spend more hours doing that than anything else. So, if you work a full time job, 2080 hours a year, you would need to spend 2081 hours a year doing real estate. You would have to document it, and the IRS would well audit you and examine your documentation. Somewhere on their web site I ran across guidelines for auditors looking at real estate investors. It said something to the effect managing rental properties is not very labor intensive, and large amounts of time claimed for such activities should be carefully scrutinized.

Also keep in mind that a big chunk of the passive loss is generated by the depreciation deduction. What the IRS gives with one hand they take away with the other. When you sell, you will have to pay "depreciation recapture tax", currently 25%. You pay that on the amount of the gain on the sale up to the amount of depreciation taken or that could have been taken. If you're in the 28% bracket, the net is the 3% difference.

Yet another thing to consider is that the $25K special allowance only applies if your AGI is under $100K. Above that it phases out, and above $150K (married or single), it is gone completely.

One final note. Good deals have a way of being profitable. Its easy to find a crappy rental that generates a passive loss. If you have a good one, one where the rent is more than 2X the P&I payment, it will tend to actually make money. The deductions allow you to shelter the rental income, but don't generate much of a loss to use against other income.