Rental Losses

Today TaxMama hears from Eileen in Portland, OR whose client was audited for her rental property, “IRS disallowed her $25,000 rental loss claiming this is a Passive deduction for her. IRS says she may deduct expenses only up to income on the property.

True, she is not a real estate professional and she does have a management firm to collect rent and respond to repair needs, however, she makes all decisions about what to do with the property e.g. repairs, roofs, painting contractors, etc. If IRS is right, what is the value of having rentals if one is not a professional real estate person?”

Hi Eileen,

The passive loss rules with respect to real estate are pretty specific in defining active participation and material participation. See IRS Publication 925, and read the material participation rules – http://www.irs.gov/publications/p925/ar02.html#d0e738
Rental property owners must log the hours spent working with the property – especially when there’s a management company handling it. Frankly, showing management fees on a Schedule E is the kiss of death for the deductions. It generally means the owner only spends an hour or so a month, if that, making decisions.

So, what’s the point of owning rental real estate?

Well, if you’re smart – to generate a positive cash flow AND for the property to appreciate in value so you can sell it a laaaarge profit. At least, that’s how I always understood it.

Do it right, and the depreciation offsets the cash flow – and you pay no tax on the income from the property.
So, it’s a pretty good deal.

And whatever losses you can’t deduct, get carried forward until you sell the property and reduce your profits.

Not a bad deal at all.

And remember, you’ll find answers to questions about rental real estate and all kinds of tax issues, free. Where? Where else? At TaxMama.com

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