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Passive activity losses: year-end tax strategy

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According to the general rule, losses from “passive” activities such as rental real estate may be used only to offset income from other passive activities. A passive activity is generally one where the investor does not materially participate in the undertaking.

However, you may benefit from a special tax break if you own rental real estate. In this case, you may use up to $25,000 of passive rental real estate losses to offset nonpassive income such as salary. This special $25,000 loss allowance rule gradually phases out for an AGI between $100,000 and $150,000.

Invest in passive income generators (PIGs) before year-end. These are investments designed to produce current passive income that can be used to absorb losses from your other passive activities.

Conversely, if you’ve already realized current income from passive activities, you might do the exact opposite: Make investments in passive activities that should provide a loss this year. If you realize passive losses up to the amount of passive income already realized, the income is effectively tax-free.

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