If you are a real estate investor or considering investing in real estate, you probably did not like the news that by default all real estate investments are considered to be passive activities. As we previously discussed, you cannot deduct passive activity losses against "active" income, you can only use it to offset passive activity income if there is any. However, there are exceptions to this general rule. The first exception is for active participation in real estate investments. If you qualify for this exception, you can deduct up to $25,000 of losses.
Only individuals, an individual's estate, or an individual's qualified revocable trust can actively participate in a rental activity. You must also own at least 10% by value of all the interests in the activity throughout the year.
What does it mean to actively participate in the real estate activity?
Active participation is a fairly relaxed standard that can be met simply by making significant management decisions. For example, this standard can be met by:
- Approving new tenants;
- Determining the rental terms; or
- Approving expenditures.
This is not an exhaustive list, so other similar decisions could be enough to qualify as active participation.
However, even if you actively participate in a real estate activity you may not be able to deduct the $25,000. The $25,000 "special allowance" phases out based upon your income. For every dollar of income you earn over $100,000 the special allowance decreases by $0.50 until it is completely phased out at $150,000 of income.
If you would like to know more about the active participation exception to the passive activity rules, please feel free to send me an e-mail.
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