Real Estate Series: Part 3 – Understanding Passive Loss Limitation Rules

There are three general categorizations of income from a tax perspective:​

1. Active Income – Earnings from job or business you actively participate in
2. Passive Income – Earnings from real estate or business you don't actively participate in (e.g., silent investor)
3. Portfolio Income – Earnings such as interest, dividends, gains from stocks and investments.

Income from one basket cannot be reduced by losses in a different basket.

For Real Estate Investors – this means you generally can't offset your active business income or wages with losses from your real estate.​

Illustrating Suspended Passive Losses​

Example:

• Real estate investor with $200k job buys a $300,000 residential rental property​
• Cost segregation study resulted in $100k of bonus depreciation in year 1​
• Net loss from property in year 1 is $80k​

Without meeting one of the applicable exceptions, these passive real estate losses become suspended, and they carry forward until there is sufficient passive income, or until you sell the property. ​

Exceptions for Passive Loss Limits​

There are exceptions that allow taxpayers to deduct real estate losses against non-passive income which require material participation. We will get into these rules in our next post, but for now, the key is to first understand the passive limits and that there are certain exceptions.​

• Short Term Rental Loophole​​
• Investors with less than $150k of non-passive income can utilize up to $25k of passive income regardless of short-term status ​
• Real Estate Professionals – Highest hurdle – likely not going to be met by average RE investor with a separate F/T job
  • More than 50% of your time must be spent materially participating in real estate business; AND
  • More than 750 hours of services in real estate businesses​​

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