Aug 01, 2019
By Robin Jackson Miller, EA Partner at Terry Lockridge & Dunn
As a rule, rental real estate is considered a passive activity. Passive activity losses can only be offset against passive activity income. However, there is an exemption you may not be aware of for rental real estate with active participation.
If you or your spouse have actively participated in a passive rental real estate activity, you may be able to deduct up to $25,000 of loss from the activity from your nonpassive income. There are two primary qualifiers: active participation and your taxable income.
You actively participate in a rental real estate activity if you (and your spouse) own at least 10% of the rental property and you make management decisions or arrange for others to provide services (such as repairs) in a significant and bona fide sense. Management decisions that may count as active participation include approving new tenants, deciding on rental terms, approving expenses, and other similar decisions. You can outsource the actual day-to-day operations if you are the final decision-maker.
This exemption has an income phase-out limitation. If your modified adjusted gross income (MAGI) is $100,000 or less ($50,000 or less if married filing separately), you may deduct up to $25,000 of qualified losses ($12,500 for married filing separately). This exemption does not apply if you were married, lived with your spouse at any time during the year, and are filing a separate return. You must live apart the entire year to qualify for this exemption if married, filed separately.
If your MAGI is above $100,000, there is a phase out of $1 for every $2 above $100,000. At a MAGI of $150,000 or more ($75,000 for married filing separately), there is no exemption.
Here is an example: Mike and Mary own a couple of apartment buildings and actively participate in the management decisions. The first part of the exemption of active participation is met.
Dividends and interest $1,000
Passive income from a limited partnership $2,000
Rental loss from the apartment buildings ($6,000)
Mike and Mary, married filing joint, will offset $2,000 of the $6,000 rental loss against the passive income from the limited partnership. However, they may deduct the remaining $4,000 in rental loss from their other income because their MAGI is less than the maximum allowed. Therefore, they can fully deduct the entire $6,000 in rental loss on their tax return.
If you would like to discuss your specific situation, please feel free to reach out to Robin Jackson Miller at firstname.lastname@example.org, or any of the accountants at Terry Lockridge & Dunn. They can be reached at 319-364-2945 in Cedar Rapids, or 319-339-4884 in Iowa City.