Deduct Your Rental Losses & Minimize Taxes Through The Real Estate Professional Classification

Many landlords experience rental losses, especially during the first several years of owning a property. If you’re experiencing these losses, you probably want to deduct them against other income, such as a job or other investments. Unfortunately, IRS rules may prevent you from deducting all or part of your rental losses, which could end up costing you thousands of dollars in extra taxes. On the other hand, if you’re turning a profit on the sale of real estate, you could be paying more money in taxes than what you should be paying.

PASSIVE LOSSES FOR TAX PURPOSES

A rental loss is a result of your operating costs exceeding the annual rent and other money you receive from a property. Or, you could show a loss for tax purposes because of depreciation, even if your rental income exceeds your operating expenses.

The IRS classifies rental losses as “passive losses” for tax purposes, which means they can only be deducted against passive income – not your job or other employment. Passive income is income that you regularly receive with little effort to maintain it. This type of income is generated from real estate rent, royalties, dividends and interest, among other activities. Rental income is deemed passive regardless of participation. Although it appears that deducting your rental losses is not an option, there are important exceptions to the rule.

Up to $25,000 of real estate rental losses can be deducted even if you are not real estate professional, but this deduction is phased out once you’re adjusted gross income increases from $100,000 to $150,000.

You must also “actively participate” in the rental activity to claim the deduction. Active participation means involvement with management decisions and having more than 10% ownership.

However, if you qualify as a real-estate professional, then you are not subject to the passive loss rules, as long as you are materially participating in the rental activity.

ARE YOU A REAL ESTATE PROFESSIONAL?

IRS section 469(c)(7)(B) requires that a taxpayer meet two tests in order to be considered a real estate professional for a taxable year. The tests are:
• The taxpayer must show that more than one-half of the personal services performed by him or her in trades or businesses were performed in real property trades or businesses in which he or she materially participated; and
• The taxpayer must show that he or she worked more than 750 hours in real property trades or businesses in which he materially participated.

Take Advantage of Important Deductions & Tax Savings through the Real Estate Professional Classification!

HOW MUCH CAN YOU SAVE?

If you meet these requirements (and materially participate in the rental activity), then your rental real estate losses are no longer considered passive, and can be deducted as ordinary losses.

Additionally, real estate professionals are not required to pay the 3.8% Medicare Net Investment Income Tax (NIIT) on their non-passive rental income. For non-real estate professionals, this tax is imposed on the lesser of their net investment income or the excess of their modified adjusted gross income over a specific threshold amount for your passive activity.

Real estate professionals generally benefit the most from the real estate classification when they sell a rental property for a gain because they’re not required to pay the 3.8% NIIT on their capital gains for their non-passive rentals.

For example, if you had a $1,000,000 gain on the sale of a property you would pay up to $38,000 in NIIT if it was passive income. As a real estate professional, you pay $0.

If you own rental property or participate in the real estate industry, make sure your tax preparer classifies you as a real-estate professional, if you qualify, so that you can take advantage of all the deductions and tax savings available to you.

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