Passive vs. Active Losses

Real estate ventures can generate substantial losses before they start to make a profit. While not necessarily desirable, these losses can be valuable at tax time, depending on whether they are considered by the IRS to be passive or active losses. BeachFleischman PLLC helps real estate owners in Phoenix and Tucson, Arizona, realize the tax benefits they are entitled to by navigating the passive activity loss rules.

Are You A Real Estate Professional?

In general, losses from passive activities cannot be deducted from income derived from nonpassive activities. For owners of rental real estate, this can be a particularly sticky situation, since the IRS assumes that rental real estate activities are passive by default—unless the owner of that real estate meets the definition of a “real estate professional.”

Qualifying as a real estate professional requires individuals to:

  • Perform at least 750 hours of services each year in real property trades or businesses, and
  • Spend more than half of their time in real property trades or businesses in which they “materially participate.”

To meet the material participation threshold, the individual must meet one of seven tests. While this is a high bar—especially for anyone with a “day job”—a couple of rules and elections can alleviate this tax burden. For example, individuals with an adjusted gross income of less than $100,000 may qualify for the “active participation” exception, which allows them to deduct up to $25,000 in losses from rental activities that otherwise would be deemed passive. The “active participation” exception is a much less stringent test to meet than the “material participation” test.

A real estate owner with more than one property also might be able to cross that “material participation” threshold more easily by making an election to group certain activities. Since many real estate portfolios are made up of some activities that have profits and others that have losses, grouping activities can result in lower net taxable income.

How the Right Accounting Firm Can Help

Maximizing the tax benefits of real estate activities requires a thorough understanding of limitations on losses, as well as the rules and elections that affect whether a taxpayer can claim deductions for those losses.

For more than 15 years, the real estate tax advisors of BeachFleischman PLLC have been helping real estate professionals and business owners:

  • Determine whether an activity is passive or active
  • Determine limitations on losses and carry forward disallowed losses to offset future taxable income
  • Make elections (such as grouping of activities) to maximize tax benefits

Contact Us

Are you an owner of rental or investment real estate? BeachFleischman PLLC can help you achieve your desired tax results by evaluating your passive and active losses. Please contact us via the submission form below.