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Qualified “real estate professionals” who own rental property have special tax advantages that other investment do not.

 

Let’s say you’re a rental property owner and you spend more on the property than you earn during the year. You’d like to deduct your loss from any non-rental income you have, thereby reducing your taxable income and lowering your taxes for the year. Unfortunately, losses from real property rentals are classified as “passive activity losses.”  Passive activity loss rules greatly limit the amount of losses that a rental property owner can deduct from his other non-passive income, such as salary or other business income. A maximum of $25,000 can be deducted from non-passive income each year, and even this is phased out if the owner’s adjusted gross income exceeds $100,000. Unused losses must be saved for future years.

 

BUT “real estate professionals” can qualify for a special exemption from these passive loss rules, allowing them to deduct any amount of rental activity losses, regardless of how high their income may be. (IRC Sec. 469©(7).) Further, real estate professionals are not subject to the 3.8 percent net investment income tax on their real estate income.

 

You qualify for the exemption, and may treat all your losses from your rental properties as active losses, only if you satisfy all three of the following tests:

 

• 51 percent Test: You (or your spouse, if you file a joint return) spend more than half of your working hours during the year working in one or more real property businesses in which you materially participate.

 

• 751-Hour Test: You (or your spouse, if you file a joint return) spend more than 751 hours a year in one or more real property businesses in which you materially participate.

 

• Material Participation Test: You and your spouse materially participate in your rental activity.

 

It’s always a good idea to check with your accountant on this, particularly the kind of records you’ll need to keep.