Rental Real Estate
A trade or business activity is considered a passive activity if the taxpayer does not materially participate in the activity.
However, rental real estate activities are considered passive even if the taxpayer does materially participate in the activity (except for real estate professionals), but there is an exception for real estate nonprofessionals. See the special allowance, next.
Special $25,000 Allowance for Real Estate Nonprofessionals
If you're not a real estate professional there's a special rule that let's you classify up to $25,000 of rental losses as nonpassive.
This means you may deduct up to $25,000 of rental losses against your other, nonpassive income (wages, interest, dividends, etc.) provided your modified adjusted gross income (MAGI) does not exceed $100,000. For every $2 your MAGI exceeds $100,000, the $25,000 is reduced $1.
For example, if your MAGI is $110,000, the $25,000 deduction is reduced $5,000 ($10,000/2 = $5,000) to $20,000. If your MAGI is $150,000, the $25,000 is eliminated ($50,000/2 = $25,000).
Qualifying for the Special Allowance:
To qualify for the special allowance you must (a) actively participate in the activity and (b) your interest (including your spouse's) must be at least 10% (by value) of all interests in the activity throughout the year.
Active participation is not the same as material participation. Active participation is a less stringent standard.
You (or your spouse, if married) may be treated as actively participating if you make management decisions in a significant and bona fide sense.
- Approving new tenants
- Deciding on rental terms
- Approving expenditures and similar decisions
Merely signing off on what a management agent does won't cut it. Merely reviewing financial statements or conducting analysis that is unrelated to the day-to-day management or operation of the activity is not treated as participation.
Records to keep:
- An appointment book
- Calendar, or
- Narrative summary
Records should show:
- Services performed and
- Approximate number of hours spent
You do not have to keep contemporaneous daily time reports, logs, or similar documents if you can establish your participation in some other way.
Using a management agent: Having an agent manage the property will not prevent you from meeting the active participation test.
- Return to the Tax Basics for Startups Table of Contents to find related links.