You can deduct passive-activity losses only up to the amount of passive-activity income that you have. Passive-activity losses include losses from most types of rental activities and losses from trade or business activities that you don’t materially participate in. An activity is a rental activity if the income is generated primarily from the use of property, rather than the performance of services.
If you have passive activity losses from rental real estate activities that you actively participate in, you’re allowed a special $25,000 allowance. You actively participate in rental real estate activities if you have a 10% or greater ownership interest throughout the year and you make management decisions, such as approving new tenants, deciding on rental terms, and approving expenditures.
From non-passive income, you can deduct the lower of:
$25,000, or
The net loss from active participation rental real estate activities.
Losses are offset against passive income before figuring the amount allowed under this provision.
Example 1: You have $5,000 in income from a limited partnership and $27,000 in losses from active participation in rental real estate activities. $5,000 of the loss offsets the passive income. Depending upon your modified AGI, you may be able to deduct the other $22,000.
The $25,000 limit is reduced by $1 for every $2 that your modified AGI exceeds $100,000. Under the $25,000 rule, no losses are allowed when your modified AGI is $150,000 or more.
For married taxpayers who file separate returns and who lived apart for the entire year, the limit is $12,500, and begins to phase out when your modified AGI exceeds $50,000. When your modified AGI is $75,000 or more, no losses are allowed. If the couple lived together at any time during the year, then no losses are allowed.
Example 2: If your modified AGI is $130,000, the $25,000 limit is reduced by $15,000:
$130,000 (Modified AGI) - $100,000 (Income limit) / 2 = $15,000 (Amount of reduction)
This means that your loss deduction from rental real estate activities with active participation is limited to $10,000:
$25,000 (Deduction limit) - $15,000 (Reduction amount) = $10,000 (Your loss deduction)
Related Topic:
Rentals and Royalties