Tax Notes for Owners

With limited exception, real estate rental losses (passive losses) cannot be used to offset other types of income such as wages, interest, dividends and gains from investments other than rental real estate.

An exception to the loss deduction rule is for taxpayers that actively participate in the rental real estate activity. To qualify for this $25,000 offset, a taxpayer must actively participate in the activity. Active participation does not require regular, continuous, and substantial involvement in an activity. A taxpayer can participate by making management decisions or arranging for others to provide services (such as repairs) in a significant and bona fide sense. Relevant management decisions include interviewing new tenants, deciding on rental terms, approving capital or repair expenditures, and similar decisions. For example, a taxpayer who owns and rents out an apartment actively participates even when he hires a rental agent and others to provide services such as repairs. The taxpayer must be personally involved in carrying out rental policy such as being involved in the tenant approval process. For married taxpayers, the participation of both spouses is taken into account, whether or not a joint return is filed.

If the total net losses exceed $25,000, the taxpayer must allocate the allowable amount among all of his eligible activities. The $25,000 loss is also limited if the taxpayer’s adjusted gross income exceeds certain amounts. This will be explained in more detail in future articles.