Rental Real Estate Activities – Passive Loss Limitations

Purchasing and renting real estate can be profitable. It can also generate significant tax benefits. However, the Internal Revenue Code limits some of the tax benefits to taxpayers who are not “real estate professionals,” as defined in IRC Section 469(c)(2).

In most circumstances, real estate rental activities are passive activities. The losses from a passive activity can only be deducted from passive income. They cannot be used to offset ordinary income. But, a “real estate professional” can deduct all rental real estate losses without limitation. They can also offset their real estate losses against non-passive income. Therefore, it is important to know what an individual must do to be a “real estate professional.”

Internal Revenue Code Section 469(c)(7), defines a”real estate professional as someone who:

Performs more than one-half of their personal services, performed in trades or businesses during such taxable year, in real property trades or businesses in which they materially participate, and

Performs more than 750 hours of services during the taxable year in real property trades or businesses in which they materially participate.

Unfortunately, meeting these requirements is just the first step. If the taxpayer has more than one rental property, the IRS and state evaluate the time the taxpayer spends on each property individually unless the taxpayer files a statement specifically electing to group the properties. I.R.C. § 469(c)(7)(A)(ii).

The IRS and state will not combine the time each spouse spends on the real estate activity to meet the material participation requirement. Each spouse must materially participate based on their own time spent. This can eliminate the tax benefits for both spouses if neither meets the requirement on their own. I.R.C. § 469(c)(7)(B)(ii). Please look for future blog articles discussing the nuances of the “material participation” requirements.

We encourage you to review the following court decisions for guidance on what it takes to be a “real estate professional” and receive the associated tax benefits.

Harnett v. Comm’r, T.C. Memo. 2011-191.

Bosque v. Comm’r, T.C. Memo. 2011-79.

Perez v. Comm’r, T.C. Memo. 2010-232.