The rental real estate loss allowance is the amount of passive losses from real estate that you can deduct each year from your earned income. If you’re not a real estate professional, you can use the rental real estate loss allowance to deduct up to $25,000 of rental losses from your earned income, as long as you made less than $100,000.
Below we’ll discuss when you can use the allowance, how to calculate your passive deductions, and how non-cash expenses on rental properties can go toward lowering your tax liability.
Definition and Example of Rental Real Estate Loss Allowance
The rental real estate loss allowance is what the IRS allows you to deduct in passive losses from real estate each year from your earned income.
It can be used to offset up to $25,000 in earned income, as long as you actively managed the real estate and earned less than $100,000 during the year. For example, if you earned $70,000 in wages and took a $13,000 loss on your rental properties, you could deduct $13,000 from your earned income.
The amount of real estate loss you can deduct starts to phase out after you earn $100,000 and continues to phase out until your income is $150,000. Once your modified adjusted gross income (MAGI) reaches $150,000 (or $75,000 if married and filing separately), the IRS does not allow deductions from loss from rental properties.
The two kinds of passive activities as defined by the IRS are:
- Trade or business activities in which you don’t materially participate during the year.
- Rental activities, even if you do materially participate in them, unless you’re a real estate professional.
Generally, passive losses can only be used to offset passive income and cannot be deducted from your adjusted gross income. However, the IRS makes an exception for losses from rental real estate, allowing a deduction of up to $25,000 annually on both passive and nonpassive or ordinary income (such as W-2 wages).
To take advantage of the rental real estate loss allowance, you also must actively participate in the management of the property.
Active participation as defined by the IRS means you owned greater than 10% of the property and made management decisions during the year.
Use IRS form 8582 to calculate the amount of allowable passive activity losses you can report each year. Real estate losses you cannot use toward a deduction in a particular tax year, also called “suspended passive losses,” can potentially be used for a deduction the following year.
How the Rental Real Estate Loss Allowance Works
In an ideal situation, you would finance the real estate purchase then charge enough rent to make the mortgage payments and cover expenses. However, some property owners can experience losses; for example, if they have periods of vacancy or spend a significant amount of money on repairs or upgrades.
Property owners experience losses from rental real estate when the income they receive from their properties is less than their operating expenses.
Let’s say you own a couple of rental properties, you have a job in another field, and you have an investment portfolio earning money. You have a property manager who keeps track of the properties, but you approve new tenants and make decisions on big expenditures.
At the end of the year, you’ve made $70,000 from your day job and $15,000 from your investments, but lost $26,000 on your rental real estate activities. You are only allowed to deduct a total of $25,000. You could apply $15,000 of your loss to the $15,000 earned from passive income from investment, and the remaining $11,000 as a deduction on the income from your job.
Consult a professional tax advisor for guidance maximizing your deductions according to your own personal financial situation.
- If you're not a real estate professional, you can deduct up to $25,000 in rental real estate losses as long as they own 10% or more of the property and participate in its management.
- Rental real estate loss allowance can be used to offset both passive and non-passive income.
- You can use non-cash expenses like depreciation and finance charges such as interest expense to reduce earned income.
- Deductible losses are phased out if you have an adjusted income of between $100,000 and $150,000.