Key Takeaways
- Rental income is generally passive income subject to passive loss rules.
- $25,000 special allowance for active participants in rental real estate.
- Phase-out: $100,000 - $150,000 AGI (50 cents per dollar over $100k).
- Real estate professionals can deduct rental losses against active income.
- Form 8582 calculates passive activity loss limitations.
- Suspended passive losses can be used when property is sold.
Rental Real Estate Activities
Why This Matters for the Exam
Rental real estate has unique passive activity rules with a special $25,000 allowance. The exam tests the allowance, phase-out, and real estate professional exception.
Expect at least 3-4 questions on rental real estate rules.
The General Rule: Rental = Passive
Rental activities are per se passive—regardless of how much you participate.
| Activity Type | Classification |
|---|---|
| Rental real estate | Passive (by definition) |
| Active business | Active or passive based on participation |
Passive Loss Limitation
Passive losses can only offset passive income:
| Income Type | Can Offset Rental Losses? |
|---|---|
| Passive income | Yes |
| Active income (wages) | No (with exception) |
| Portfolio income (dividends) | No |
The $25,000 Special Allowance
Exception: Active participants in rental real estate can deduct up to $25,000 of rental losses against active income.
| Requirement | Description |
|---|---|
| Active participation | Make management decisions |
| Ownership | At least 10% ownership |
| AGI limit | Phase-out begins at $100,000 |
Active Participation (Not Material)
Active participation is a lower standard than material participation:
| Active Participation | Description |
|---|---|
| Approve tenants | Make leasing decisions |
| Set rental terms | Determine rent amounts |
| Approve repairs | Authorize maintenance |
| Management decisions | Overall decisions |
You can hire a property manager and still actively participate.
AGI Phase-Out
| AGI | Allowance |
|---|---|
| <$100,000 | Full $25,000 |
| $100,000 - $150,000 | Reduced (50¢ per $1) |
| ≥$150,000 | $0 |
Formula: Allowance = $25,000 - [($AGI - $100,000) × 50%]
Phase-Out Examples
| AGI | Calculation | Allowance |
|---|---|---|
| $80,000 | Full | $25,000 |
| $120,000 | $25,000 - ($20,000 × 50%) | $15,000 |
| $140,000 | $25,000 - ($40,000 × 50%) | $5,000 |
| $150,000+ | $25,000 - ($50,000 × 50%) | $0 |
Real Estate Professional Exception
Real estate professionals can deduct all rental losses against active income:
| Requirement | Test |
|---|---|
| 750+ hours | In real property trades or businesses |
| More than 50% | Of personal services in real estate |
| Both tests | Must meet BOTH |
Real Property Trades or Businesses
| Qualifies | Does Not Qualify |
|---|---|
| Real property development | Passive rental only |
| Construction | Hotel employees |
| Reconstruction | Non-real estate work |
| Acquisition | Finance/lending |
| Management | Property appraisal only |
| Leasing | |
| Brokerage |
Suspended Losses
| Situation | Treatment |
|---|---|
| Losses exceed allowance | Suspended (carry forward) |
| Future passive income | Can use suspended losses |
| Fully taxable sale | All suspended losses released |
Form 8582
Form 8582 (Passive Activity Loss Limitations) calculates:
- Total passive income and losses.
- Allowable current-year deduction.
- Suspended losses carried forward.
Real-World Scenario
Scenario: You have $40,000 of rental losses, AGI of $120,000, and actively participate in managing your rental property.
- Phase-out: $25,000 - [($120,000 - $100,000) × 50%] = $25,000 - $10,000 = $15,000.
- Allowable loss: $15,000 against active income.
- Suspended: $25,000 ($40,000 - $15,000) carries forward.
On the Exam
Expect 3-4 questions on rental real estate, typically:
- Allowance Questions: "What is the rental real estate loss allowance for active participants?"
- Phase-Out Questions: "At what AGI is the $25,000 allowance fully phased out?"
- REP Questions: "How many hours must a real estate professional work in real estate?"
- Suspended Loss Questions: "What happens to disallowed passive losses?"
The key is to remember: $25,000 allowance for active participants. Phase-out $100k-$150k. REP = 750+ hours and 50%+ in real estate. Suspended losses release on sale.
What is the rental real estate loss allowance for active participants?
At what AGI is the $25,000 allowance fully phased out?
How many hours must a real estate professional work in real property activities?