"Passive activity loss" (PAL) rules say that losses from passive activities are limited to annual passive activity income. In general, rental real estate is treated as a passive activity.
Strategy: Put in enough time to qualify as a "real estate professional." If you do, you'll effectively exempt your rental real estate losses from the PAL rules. That allows you to deduct rental real estate losses against income from all other sources (not just passive income).
To qualify as a real estate professional, you must spend more than half of the time performing personal services as a material participant in real estate businesses and at least 750 hours during the year materially participating in real estate activities.
Key point: To pass this test, you must prove regular, continuous and substantial involvement in the activities. A court recently rejected a rental-property owner who tried to claim he qualified as a real estate professional. Court's reason: He was unable to establish a record—other than his own "guesstimates" and vague affidavits—that he had spent enough time working as a material participant in real estate. (D'Avanzo, U.S. Court of Federal Claims, 00-776T, 7/26/05)
Tip: If you can't qualify as a real estate professional, all is not lost. At the very least, if you can show "active participation" in rental real estate activity—for example, you manage the properties—you may still be able to deduct up to $25,000 of passive rental real estate losses against nonpassive income. (The $25,000 allowance phases out for people with adjusted gross incomes (AGI) above $100,000 and is completely phased out once AGI reaches $150,000.)
- Small Business Tax Deduction Strategies No matches