Active vs. Passive & Tax Consequences

[John McAuley]

Hey Everyone,

This is the first year we will have rental property on our tax returns. I'm familiar with W2 income and income from our other businesses (LLCs). However, I'm not clear on the active vs. passive rules when it comes to being able to offset other income with my passive rental losses. I'm above the 100K limit on rental losses and since I only have my first rental, it's hard for us to make the argument that my wife spends the 750 hours on our real estate. But does this mean that we won't be able to deduct any losses from our real estate LLC holding the property or does it just mean the rental property itself. In other words, there have been a lot of expenses associated with the typical process of buying a property (mileage, legal fees for LLC formation, property management software, etc.). Are all of those expenses under the LLC prohibited as well or will I at least be able to use a portion of the LLC expenses to offset my other income but not the losses of the property (interest, depreciation, etc.)

Hopefully it is clear what I'm trying to ask. I just find it very hard to believe that I would be disallowed to use the loss from this business like any other business I have just because it's a real estate focused LLC and I exceed the income limits.

Thanks in advance for any help.

John

[Brandon Hall]

@John McAuley you can always deduct your expenses - the question is whether or not doing so causes a passive loss from your rental real estate activities. The next question is whether or not you can use that passive loss on your 1040. If you can't, you have what's called "suspended passive losses" which are then carried forward until used up.

If your MAGI is less than $100k, you can deduct up to $25k of passive losses on your 1040. If MAGI is between $100k and $150k, the $25k passive loss deduction phases out. If MAGI is above $150k, you can't deduct passive losses unless your spouse qualifies as an RE pro which is unlikely with a small portfolio.