Deduction of Losses from Rental Real Estate
Can Losses from Rental Real Estate be deducted?
Rental activities are treated as per se passive. Passive losses cannot be offset to reduce active/nonpassive income. However, a statutory exception, IRC Section 469(c)(7), was enacted in 1993 which provided that certain real estate operators need not treat their interests in rental real estate as passive activities. The IRS issued regulations, Regs. 1,469-9(g), to clarify the statute.
Generally, there are two requirements for individuals to qualify under the exception which may allow deduction of the rental real estate losses. First, the individual must provide more than half of his personal services in trades or businesses which are real property trade or businesses. While this determination may seem simple at first glance it is anything but simple. Generally," real property trades or businesses" are defined as "any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business." It is clear that personal services performed as an employee do not count as performed in real property trades or business unless onn is a 5% ower of the employer. Other limitations also apply.
Second, during the taxable year the taxpayer must have performed more that 750 hours of services in real property trades or business in which he materially participates. The code and regulations do not provide much guidance to determine how material participation is measured.
There is a limited exception in the passive loss rules for real real estate activities which permits certain taxpayers to use up to $25,000 of losses from rental reas estate against nonpassive income. The taxpayer must actively participate in the rental real estate activity. Active participation can be satisfied without regular, continuous, and substantial involvement in the activity. It can be established by the performance of purely management function. However, there is a phase out rule: the $25,000 amount will be reduced by 50% of the amount by which the adjusted gross income of the taxpayer for the taxable year exceeds $100,000.
This narrative is intended to be introductory only; this area of the law if fraught with ambiguities and professional assistance is necessary to navigate this tax law.
Thomas F. DiLullo, P.C.
A Hackensack law firm serving Bergen County, as well as, New Jersey, New York and Connecticut, and Federal tax cases nationwide.