Real Estate Tax Deductions Part II

[Julio Gonzalez]

In part II of Real Estate Tax Deductions, I want to talk about the Passive vs. Non-Passive Rule. If your income is less than $150,000 per year, you are allowed to claim up to $25,000 in passive losses. Rental income from real estate is considered passive income, therefore if you incur losses on a rental investment, the loss is considered passive. Additionally, if you are a silent partner on the investment, this is also considered passive.

This law was passed to try to hinder wealthy individuals from using depreciation losses to offset taxable income. However, there are two scenarios in which you can earn greater than $150,000 per year and are still allowed to claim up to $25,000 in passive losses by combining gains and losses under Section 469.

The first way is to combine rental property with investments in which you also materially participate in that have passive activities that generate income. (There are many ways to be considered “materially participating '' including time spent on the activity of 100 hours per year or greater.) Examples include:

• Common ownership
• Common control
• Similar businesses
• Interdependent activities
• Geographical location

The second way is to combine rental property with other passive activities that generate losses as long as you or your spouse are considered a real estate professional. There are two main tests (only one needs to be passed) in order to qualify as a real estate professional.

1. At least 50% of your time is spent on the real estate business.
2. You (or your spouse) spends a minimum of 750 hours per year with hands-on management of the rental properties and operations.

Most taxpayers choose option one if they also have other investments that produce income such as partnerships. If you don’t have any other passive income producing activities, you must meet one of the two requirements listed above to qualify as a real estate professional. There are a few other rules that the taxpayer must also satisfy including excess business loss rules, at-risk rules, and basis limitation rules. I will be covering these next week in part III!

Be sure to check back next week for part III!