$25,000 Loss Allowance on Rental Property
How can you deduct a loss from residential rental property you own and are
The problem with rental activities is that they generally fall into the category of
“passive” activities. Thus, rental losses you incur can only be deducted currently
against passive income.
However, if you “actively participate” in the residential rental activity, you may be
able to deduct a loss of up to $25,000 against ordinary (nonpassive) income such as your
wages or investment income. You actively participate in the rental activity if you make
key management decisions such as whom to rent to, the rental terms, approving capital
expenditures, etc. You also can show active participation if you arrange for others to
provide services. Active participation does not require regular, continuous, substantial
involvement with the property. But in order to satisfy the active participation test, you
(together with your spouse) must own at least 10% of the rental property. Ownership as a
limited partner does not count.
If you meet the above tests, you can claim up to $25,000 in losses against nonpassive
income ($12,500 if you're married, file separately, and live apart from your spouse for
the entire year—but if you're married, file separately and don't live apart from your
spouse for the entire year, you're not eligible for this break at all). If your adjusted
gross income (AGI) is above $100,000, the $25,000 allowance amount is reduced by one-half
the excess over $100,000. (If you're married, file separately and are eligible for the
break, the $12,500 allowance amount is reduced by one-half the excess over $50,000.) Under
this rule, if AGI is $150,000 or more ($75,000 or more for eligible married taxpayers who
file separately), the allowance is reduced to zero. (For these purposes, AGI is modified
to some extent, e.g., you ignore taxable Social Security income and the Individual
Retirement Account (IRA) deduction.)
Example. Tina, who's single, has adjusted gross income of
$120,000. Thus, one-half of the $20,000 excess ($120,000 - $100,000) equals $10,000.
Tina's maximum loss allowance is reduced from $25,000 to $15,000.
Losses which are not allowed because of the amount limitations do not simply disappear.
They are carried forward and can be deducted against nonpassive income in future years if
you continue to actively participate in the rental real estate activity which originally
generated the losses. But if you cease to actively participate, the carried-forward losses
are treated as passive activity losses which may only be used to offset passive activity
income or your gain when you dispose of your ownership interest in the activity.