10.2 Rental Real Estate Loss Allowance of up to $25,000
If you are not a real estate professional (10.3) but you actively participate by performing some management role in a real estate rental venture, you may deduct up to $25,000 of a real estate rental loss against your regular, nonpassive income such as wages. Your rental loss is still “passive”, but the allowance lets you deduct the loss (up to $25,000) as if it were a nonpassive loss. The allowance is phased out if your modified adjusted gross income (MAGI) is between $100,000 and $150,000. You generally take the allowance into account on Schedule E, but Form 8582 is sometimes required (10.12).
If you are married filing separately, you are not eligible for the special loss allowance unless you lived apart for the entire year, and in that case, the allowance is limited to $12,500; see below. The allowance applies only to real estate rentals not excluded from the rental category by the rules at 10.1. For example, short-term vacation home rentals averaging seven days or less do not qualify for the allowance. The allowance applies only to real estate rentals, not to any rentals of equipment or other personal property.
A trust may not qualify for the $25,000 allowance. Thus, you may not circumvent the $25,000 ceiling or multiply the number of $25,000 allowances by transferring rental real properties to one or more trusts. However, an estate may qualify for the allowance if the decedent actively participated in the operation. The estate is treated as an active participant for two years following the death of the owner.
Married filing separately.
If you file separately and at any time during the taxable year live with your spouse, you are not allowed to claim any allowance. If you are married but live apart from your spouse for the entire year and file a separate return, the $25,000 allowance and the adjusted gross income phase-out range are reduced by 50%. Thus, the maximum allowance on your separate return is $12,500 and this amount is phased out by 50% of MAGI over $50,000. Therefore, if your MAGI exceeds $75,000, no allowance is allowed.
Active participation test must be met.
To qualify for the allowance, you must meet an active participation test. Having an agent manage your property does not prevent you from meeting the test, but you must show that you or your spouse participates in management decisions, such as selecting tenants, setting rental terms, and reviewing expenses. The IRS may not recognize your activity as meeting the test if you merely ratify your manager’s decisions. You (together with your spouse) must also have at least a 10% interest in the property. Limited partners are not considered active participants and do not qualify for the allowance.
Planning Reminder
If a decedent actively participated in property held by an estate, the estate is deemed to actively participate for the two years following the death of the taxpayer.
Figuring the $25,000 allowance.
First match income and loss from all of your passive rental real estate activities in which you actively participate. A net loss from these activities is then applied to net passive income (if any) from other activities to determine the $25,000 allowance. Keep in mind that rental income or loss from renting a personal residence is disregarded in figuring the $25,000 allowance if the rental is not a passive activity, and it is not a passive activity if your personal use of the home during the year exceeds the greater of 14 days or 10% of the days the home is rented at a fair market rental amount (9.7). The allowance may not be used against carryover losses from prior taxable years when you were not an active participant.
Phaseout of the allowance.
The maximum loss allowance of $25,000 ($12,500 if married filing separately and living apart for the entire year) is reduced by 50 cents for every dollar of modified adjusted gross income (MAGI) over $100,000 (or $50,000 if married filing separately).
Modified adjusted gross income (MAGI). For purposes of the allowance phaseout, MAGI is adjusted gross income shown on your return, but you should disregard:
- Any passive activity income or loss.
- Any loss allowed for real estate professionals (10.3).
- Taxable Social Security and railroad retirement payments (34.3). For example, if your adjusted gross income on Form 1040 is $90,000, and that includes $5,000 of taxable Social Security benefits, your modified adjusted gross income is $85,000.
- Deductible IRA contributions (Chapter 8).
- Deductible tuition and fees (33.13).
- The deduction on Form 1040 for one-half of self-employment tax liability (45.3).
- Deductible student loan interest (33.13).
- Overall loss from a publicly traded partnership (see instructions to Form 8582).
- Excluded interest on U.S. savings bonds used for paying tuition in the year the bonds are redeemed. If you are allowed to exclude the interest from income for regular tax purposes (33.4), the interest must still be included for purposes of the allowance phaseout.
- Employer-provided adoption assistance that is a tax-free fringe benefit (Chapter 3). The assistance must be included in MAGI for purposes of applying the allowance phaseout rule.
- The domestic production activities deduction (40.23).
Filing Tip
| If modified AGI is– | Loss allowance is– |
| Up to $100,000 | $25,000 |
| 110,000 | 20,000 |
| 120,000 | 15,000 |
| 130,000 | 10,000 |
| 140,000 | 5,000 |
| 150,000 or more | 0 |
A rental loss that is carried over because it exceeds the allowance may be deductible in a later year if you continue to meet the active participation rule.
| Modified adjusted gross income | $ 120,000 |
| Less: amount not subject to phaseout | $ 100,000 |
| Amount subject to phaseout | $ 20,000 |
| Phaseout percentage | 50% |
| Portion of allowance phased out | $ 10,000 |
| Maximum rental allowance offset | $ 25,000 |
| Less: Amount phased out | $ 10,000 |
| Deductible rental loss allowance in 2012 | $ 15,000 |
| Passive loss from rental real estate | $ 31,000 |
| Less: Passive income from partnership | $ 5,000 |
| Passive activity loss | $ 26,000 |
| Less: Deductible rental loss allowance in 2012 | $15,000 |
| Carryover loss to 2013 | $ 11,000 |
Real estate allowance for tax credits.
On Form 8582-CR, a deduction equivalent of up to $25,000 may allow a credit that otherwise would be disallowed. You must meet the active participation test in the year the credit arose. The $25,000 allowance is generally subject to the regular MAGI phaseout rule.
To claim low-income housing and rehabilitation credits, you need not meet the active participation test. Furthermore, for rehabilitation credits and credits for low-income housing property placed in service before 1990, the phaseout for the $25,000 allowance starts at MAGI of $200,000 ($100,000 if married filing separately and living apart the entire year); thus, the deduction equivalent is completely disallowed when MAGI reaches $250,000 ($100,000 if married filing separately). The phaseout is figured on Form 8582-CR. There is no MAGI phaseout for low-income housing property placed in service after 1989, unless you have a pass-through interest in a partnership or S corporation that you acquired before 1990.
The deduction equivalent of a credit is the amount which, if allowed as a deduction, would reduce your tax by an amount equal to the credit. For example, a tax credit of $1,000 for a taxpayer in the 25% bracket equals a deduction of $4,000 and would come within the $25,000 allowance provided you actively participated. In the 25% bracket, the equivalent of a $25,000 deduction is a tax credit of $6,250 ($25,000 × 25%). Thus, if you have a rehabilitation credit of $7,000 and you are in the 25% bracket, the $25,000 allowance may allow you to claim $6,250 of the credit, while the balance of the credit would be carried forward to the following year.
If in one year you have both losses and tax credits, the $25,000 allowance applies first to the losses, then to tax credits from rental real estate with active participation, then to tax credits for rehabilitation or low-income housing placed in service before 1990, and finally to tax credits for low-income housing placed in service after 1989.
The allowance and net operating losses.
If losses are allowed by the $25,000 allowance but your nonpassive income and other income are less than the loss, the balance of the loss may be treated as a net operating loss and may be carried back and forward; see 40.18 for further details.