One of the top areas for IRS exams related to individual returns is Schedule E page 1. The agents’ eyes glimmer when they see rental losses. The rules are complicated involving the deductibility of real estate losses, so let me recap the basics:
- Typically rental real estate losses are considered passive. Passive losses can only be deducted to the extent there is passive income; otherwise, they are carried forward to the next year.
- If you actively participate in your real estate activities (making significant management decisions, arranging for others to provide repairs services, etc), you can deduct up to $25,000 of passive losses regardless of passive income.
- If you qualify as a real estate professional, the losses will not be considered passive and will not be subject to the limitation rules.
- To qualify as a real estate professional:
- More than half of the time you spend providing services during the year for trade or business activities must be related to your real estate activities
- You must materially participate in the real property activities for more than 750 hours during the year (this is determined separately for husband and wife, not aggregated)
Material participation has its own separate tests (7 to be exact), which I will not go into now. The general idea is that material participation means you are regularly, continuously and substantially involved in the operations of the activity.
The 750-hour test is tricky, so the most important thing to remember when dealing with rental real estate is to document your time. Keep a calendar or a daily log. Document the hours you spend performing services related to your real property trade or business vs. other trade or business time. Also, make sure you separately document the time you spend on each property.
While this documentation can be done simply with a spiral bound notebook, today’s technology offers tons of applications for efficient time tracking. Just from a Google search I found several applications including HoursTracker- Time & Time Tracker (compatible with iPhones and iPads) and Toggl (compatible with Mac, PC, iPhone, IPad, Ipod or Android).
As always, please discuss any questions you have with your trusted tax professional.
Jessica Miles, CPA; Supervisor