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UNLIMITED LOSS DEDUCTIONS FOR REAL ESTATE PROFESSIONALS

 

Owning rental property may yield large financial gains in healthy markets.  Recently, however, fluctuations in the real estate and housing markets have produced conditions which can lead to great financial losses.  Because owning real estate is considered a “passive activity” by the tax code, there are certain restrictions and limitations regarding the amount of loss a taxpayer can claim in a taxable year.  Some losses may have to be carried into future years and this carrying over might not result in the ideal financial situation for the taxpayer in the year he/she might need it most.  

 

Internal Revenue Code section 469: Passive Activity Losses

 

In general, loss or credit from passive activities must be carried over to the next taxable year. The Internal Revenue Code (IRC) specifies rental activity as being included in the term passive activity, even if a taxpayer materially participates in the rental activity.  However, IRC section 469 does allow a certain dollar amount of losses or credits to be claimed for rental real estate activities.  A natural person can claim up to $25,000 of loss or credit in a taxable year if such loss or credit is attributable to all rental real estate activity in which the individual actively participated in such taxable year.  But if a taxpayer’s adjusted gross income (AGI) is more than $100,000, then the allowance slowly phases out, reducing the $25,000 by 50% of whatever amount exceeds the $100,000 (not to go below zero).  For example:

 

 

AGI

Reduction

Allowable Loss or Credit

Taxpayer A

$110,000

50% of 10,000 = 5,000

$20,000

Taxpayer B

$142,000

50% of 42,000 = 21,000

$4,000

Taxpayer C

$150,000

50% of 50,000 = 25,000

$0

 

For anyone with an AGI over $150,000, the $25,000 offset in the IRC is eliminated.  Fortunately, a taxpayer may be able to gain unlimited loss deductions if they or their spouse (if filing jointly) qualify as a real estate professional under IRC section 469.

 

Real Estate Professionals

An owner of rental real estate may qualify as a real estate professional and thereby not have his or her rental activity considered a passive activity.  To qualify, more than one half of the real estate professional taxpayer’s or spouses’ personal services and more than 750 hours per year must be performed in real property trades or businesses in which the real estate professional taxpayer materially participates.  This includes management, operation, construction and almost everything related to the real estate business.  Regular, continuous, and substantial activity is considered “material.” The one-half/750-hour test is applied to each interest unless the taxpayer elected to treat all rental real estate interests as one.  This is a very important election and must be properly executed.  

 

This unlimited loss deduction for real estate professionals may bring substantial monetary benefit to property owners.  Contact our tax law firm to determine if you currently qualify or if you can make changes that will enable you to take advantage of the tax code which can result in a very significant reduction in your taxes. 

 

We represent many individuals and businesses from many industries, including but not limited to, real estate management, construction, professional service firms, medical practices, manufacturing, retail, technology development, etc.   We provide comprehensive tax litigation, planning, and defense representation.   We invite you to contact our law firm to discuss your legal questions.   Please feel free to use our contact form or phone us at (415) 394-7200.

How to deduct unlimited real estate losses against other income while avoiding the pitfalls of tax laws.

By Stephen Moskowitz, J.D. LLM., Senior Partner and co-author Anthony Diosdi, J.D.., LLM., Senior Associate
Date Published: Dec 08 San Francisco Business Times

The Law Offices of Stephen Moskowitz, LLP has seen a major increase in audits and one of the common red flags we are seeing are taxpayers deducting real estate losses against ordinary income.

The Internal Revenue Code places constraints on netting real estate loss against income from other sources. As a general rule, a taxpayer cannot offset passive losses against wage, interest, or dividend income. The rental of real estate is generally a passive activity. However, Congress has promulgated special tax laws for passive losses associated with real estate rental income. Federal tax law provides that up to $25,000 of losses associated with real estate rental activities can be netted against ordinary income.

The key to claiming real estate losses from rental property is to qualify by actively participating in rental activity. Active participation standards are met if you own at least ten percent of the rental property and have substantial involvement in managing the rental (defined as you spending more than 500 hours at the activity and no one else spending more hours in that particular real estate activity than you). If you are a limited partner in the real estate rental activity, you will not qualify for the deduction. The $25,000 special loss allowance is phased out by fifty percent if your modified gross income exceeds $100,000. It reaches zero by the time your income hits $150,000.

The ideal scenario may be to take unlimited losses against ordinary income. For tax purposes, people who meet eligibility requirements are able to deduct against ordinary

income (wages, dividends, interest, etc) real estate losses in unlimited amounts, a departure from the general rules, which would prohibit this. To qualify for this unlimited tax deduction a taxpayer must meet the tax requirement known as being a “real estate professional.” For tax purpose, qualifying as a “real estate professional” means that either you or your spouse:

  • Must materially participate in the rental real estate activities.
  • More than fifty percent of your time spent working during a calendar materially participate.
  • Must s pend more than 750 hours of service during a calendar year performing real estate rental activities.

It is extremely important that you keep a timely log of all activities performed in real estate. The IRS will likely challenge logs prepared after the fact with “ballpark” estimates. Therefore, detailed logs are extremely important to substantiate your participation in the real estate rental market to the IRS in the event of an audit.

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