I've been getting questions about rental real estate and if you can use losses to offset non passive income. So here are the rules.
The IRS classifies rental income as passive which means if you create paper losses (from depreciation) the IRS will only let you use those losses to offset other passive income. That means if you have a $100,000 loss on a property you can't use that loss to offset your $100k of W2 or self employment income.
However, there are exceptions. Here's part one.
If you can qualify for Real Estate Professional Status, the passive loss rules no longer apply. However qualifying is very difficult and not really possible if you have a full time job.
To qualify a few of the main tests are:
- you have to spend more than 750 hours of your time in real estate activities or services during the year
- you need to spend more than half of your time during the year in real estate. So if you work 40 hours a week you need to work 41 hours in real estate (not practical for most)
- you need to materially participate in your rental real estate (easiest one to pass is spending more than 100 hours in the RE activity during the year)
Good news though! If you have a non working spouse who can manage the day to day of your rental properties, he or she can qualify (must still meet all tests) and because you file MFJ, if he or she has RE Pro Status, losses from your rentals can offset your non passive income. Essentially it's kind of like you qualify for REP status as well. So if you made $300k as an attorney and one of your rentals had a $100k loss from depreciation, your taxable income is now $200k for the year. Pretty substantial tax savings!
Hope this helps. And if this is something you think you can qualify for, please let me know and let's have a call to discuss.