How to get the tax advantages against W2 income

Question

Hello,

I own 2 rental properties with a partner and also have a W2 job. My wife doesn't work but doesn't have a real estate agent license. She work on the rental properties in many ways. But her name is not on the properties.

As I understand, we don't get any advantage in the real estate losses against my W2 income. Are there specific conditions that are required to claim a loss for my wife since she worked on rental properties?

Thanks.

Account Closed · Answer

Hey @Lahiru S Hettiarachchi Gamage,

To clear things up for you:

Rental real estate activities are default passive in the eyes of the IRS. Real estate professional status is valuable because it allows us to reclassify these rental activities to active. Why would we want to do that? Because if we can take deprecation losses from our rentals, we can use that loss to offset our other active income (from being a broker for example).

To qualify for real estate professional you need to

1. spend 750 hours working in a real property trade or business and more time in this then any other work activity.

2. Materially participate in your rental activities

How do we materially participate in our rental activities?

There is a test for that. Technically there are 7 ways, but for our purposes, we want to pass one of these three:

1. spend 500 hours materially participating in the rental activities

2. Spend 100 hours materially participating and more time then anyone else involved (cleaners, maintenance people etc)

3. Spend more time then anyone else doing all substantial services. (do ALL the work yourself)

What is "materially participating"? We take this to mean (based on 100s of real tax court cases) any activities integral to the business of running a rental. Meaning: if the business can function without you doing it, IT DOES NOT COUNT! Education and research hours, "managing the property manager" all have failed under audit historically.

There is a lot more nuance here I could go into, but I would strongly advice you talk with a real estate-focused tax professional. Not understanding and following the rules can cost you greatly. I hope this helps get your situation on the right track and gets the conversation going with your accountant.

Lahiru S Hettiarachchi Gamage · Answer

Fact that I can keep these expenses reported and "retained" on IRS Form 8582 is something new for me.  I think this is the best way forward since it is hard to prove "Material Participation".Thanks a lot.

Lahiru S Hettiarachchi Gamage · Answer

Thank you all for detailed responses.

Andrew Reyes · Answer

Lahiru - Link below is a great article covering this topic. Note that using a spouse's hours can help you meet the material participation requirements. However, as the owner you still need to spend more than 50% of personal services and more than 750 hours on the real estate business on your own.

Alternatively, short-term rentals are generally treated as active business income and therefore are eligible to offset w-2 income.

Navigating the Real Estate Professional Rules

"When measuring material participation, a married taxpayer is required to count any hours performed by his or her spouse, even if the spouse does not own an interest in the business or if no joint return is filed.32 While this rule is advantageous because it makes it more likely the taxpayer materially participates in the real property trade or business, it is a trap for the unwary in the real estate professional context, as discussed below in Step 3.""Step 3: Total the Hours From Real Property Trades or Businesses in Which the Taxpayer Materially Participates

Next, the taxpayer totals the hours spent in those real property trades or businesses in which the taxpayer materially participates. The statute makes clear, however, that while a married taxpayer includes the hours of his or her spouse in determining whether the taxpayer materially participates in a real property trade or business, the taxpayer must pass the two quantitative tests of Sec. 469(c)(7)(B) using only his or her own hours.35"

Benjamin Weinhart · Answer

Hi Lahiru,

Great question, if your wife has been considered to meet the threshold for "Material Participation" in the business, then you would be able to take these losses. There is also an up to $25,000 allowance if she doesn't quite meet the material participation threshold, but is still considered to actively participate. This allowance does have a phase out related to your income, so it would vary depending on you and your wife's specific circumstance. IRS Publication 925 goes into more detail about this.

If you aren't able to qualify for either, you still do get advantages in that you would be allowed to carryforward these passive losses to a future year to offset future passive gains. These are reported and "retained" on IRS Form 8582.

Of course, if you are unsure or would like additional guidance in determining what might fit your specific situation, please reach out to a CPA/Tax Professional who may be able to assist. Thanks!

How to get the tax advantages against W2 income

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