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Updated 12 months ago on . Most recent reply

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Kevin Luttrell
  • Lender
  • Orange County, CA
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Forced to take $25k passive activity loss deduction?

Kevin Luttrell
  • Lender
  • Orange County, CA
Posted

Hi All! Hoping someone can help me with this question. 

For the last couple years I have had losses on my tax returns from passive rental real estate activity. I am not considered a "real estate professional" by the IRS definition. I understand that passive losses cannot reduce your taxable income and must be rolled over to be subtracted from future passive income, UNLESS you meet the special allowance that says you may deduct up to $25k in passive losses from taxable income if your modified AGI is less than $100k that year. I fall into that category. 

The problem is, I don't want to take the $25k deduction. My taxable income is actually so low in 2023 that if I take the $25k special allowance deduction for passive losses and the regular standard IRS deduction, my taxable income is negative. So right now my return shows me taking this full $25k passive loss deduction and only a portion of the standard deduction (keeping taxable income at $0). So I'm not benefiting from the full standard deduction because of the passive loss deduction. 

My tax preparer says there is no way for her to not apply the $25k passive loss deduction. I have to take it. I have a hard time believing this since the IRS describes it as a "special allowance" and "exception to the general rule". 

Any tax experts know if this is true or not? Am I forced to take the $25k passive loss deduction since I qualify for it? 

Most Popular Reply

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Michael Plaks
#1 Tax, SDIRAs & Cost Segregation Contributor
  • Tax Accountant / Enrolled Agent
  • Houston, TX
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Michael Plaks
#1 Tax, SDIRAs & Cost Segregation Contributor
  • Tax Accountant / Enrolled Agent
  • Houston, TX
Replied

@Kevin Luttrell

A lot of fuzzy ideas here on this thread, very little substance. 

1. $25k special allowance is not optional. You cannot opt out of it, even though it would be beneficial in your situation.

2. You can try to intentionally fail to qualify for it. However it's not as simple as was suggested here earlier. The qualification is not material participation but active participation. This is a very soft standard. Basically if you're making any decision related to this property, such as approving a tenant or hiring a contractor - you already actively participate. And required to apply $25k.

3. If you own the property in an LP - limited partnership - then you fail active participation by statute and accomplish what you want. However, whether it's worth structuring your ownership via an LP for this purpose is highly debatable and is case-by-case. Important: LP, not LLC! Tax treatment of LLCs is very controversial in this case. Some tax pros may decide that an LLC would work for you, and again, it is case-by-case.

4. In your situation, you can plan to minimize your losses or to trigger passive gains to absorb these losses. This is a case-by-case high-end tax planning requiring professional help.

  • Michael Plaks
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