Forced to take $25k passive activity loss deduction?

Question

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?

Michael Plaks · Answer

@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.

David M. · Answer

Account Closed I think that's why we prefer to find qualified accountants and tax strategists instead of a somebody to do data entry into a piece of software.

@Kevin Luttrell have you been taking these deductions previously?  Or, just do this:  tell your accountant that you don't meet the criteria.  I think one of them is 500 hours per property.  At least from the tax preparer's point of view, I think it'd be a fraudlent return so she'd have to override it.  ... you lost all your records of how many hours you spent on the properties... whatever...  Its a quick google search and you can see the other qualifications.  Silly, dumb software.

But I certainly like your thinking --- have to be long term tax efficient.  Keep the PAL.  Save it up for when you sell.  I've been liquidating my properties and I'm paying less/little tax because of it.  I'm getting access to all my cash and not having it locked up in a 1031.  Been tracking this for over 20years!!

Michael Plaks · Answer

Stocks are not passive income. They are portfolio income and will not absorb losses. However, generating capital gains from stocks CAN raise the total income above $150k and block the $25k. Yet another tax planning opportunity, but like other opportunities, it requires advanced planning.

Account Closed · Answer

Hi I am not aware of any laws forcing you to take that passive loss. It should be able to be simply carried forward. Please correct me fellow accountants!

David M. · Answer

@Bill Brandt Oh okay.  Maybe I misread, too!!

David M. · Answer

@Bill Brandt how do you figure?  Its already 2024.  OP would have to go back in time to sell in 2023... LOL

Joshua Davidson · Answer

Hi @Kevin Luttrell,

You asked a very good question. I have been digging into this for the last 30 minutes and I haven't been able to find anything that EXPLICITLY says that you are able to opt not to take the deduction and just carry it over. I even opened up my tax preparation software and couldn't find an option that says anything on the matter.

I will keep looking and keep you posted if I find anything. All in all, I hope you're able to get your answer and I will be following this post because I'm curious as well!

David M. · Answer

@Kevin Luttrell

Personally, I don't think you have to...  The only thing I've heard of having to take is depreciation.  Otherwise, it'd be as if the IRS will chase after you for not itemizing your deductions instead of taking the standard deduction.

For the same but different, I qualified for REPS the past few years but didn't claim it.  My cpa was well aware.

In your case, you just "fill out the forms differently."  The irs is going to going to come after you for paying more tax????

David M. · Answer

@Kevin Luttrell oh, and I think the issue may be that since pretty much all accountants/preparers use a tax software, they follow whatever the software does. So, if the software doesn't let you do it, then they just blindly follow the software.  Either they need to figure out how to override the defaults, or perhaps you just fillout a paper copy of the return and mail it in...  good luck.

Kevin Luttrell · Answer

Thank you all very much for your responses! You're confirming exactly what I suspected.

@Joshua Davidson I suppose the question is: If the IRS doesn't explicitly say that I am able to opt not to take the deduction, does that mean I'm not allowed to? Or since the IRS doesn't explicitly say that I must to take the deduction, can I choose not to?

@David M. Account Closed I agree, I think the tax software is the problem here and my tax preparer just doesn't know what to do since the software is having me take the deduction.

Forced to take $25k passive activity loss deduction?

Most Popular Reply