Many individuals looking to diversify their investments with real estate often question whether there would be a tax benefit to them by owning rental real estate.  The following is a quick summary of how the tax rules work for rental properties, however, there are many additional rules which may require additional discussion, so we suggest contacting your tax advisor if you would like to address how these rules affect you and your real estate investments.

Rental activities are generally treated as passive activities, limiting the ability of taxpayers to offset losses from such activities against ordinary income.  Generally, passive rental losses can offset other passive income, are carried forward if the passive losses are greater than passive income and cannot offset ordinary income.

There are also rules as to whether the taxpayer is actively participating in the management and operations of the rental, which could allow some of the losses to be offset against ordinary income, depending on your Adjusted Gross income levels.

For this discussion, we are focusing on a special rule that applies to individuals who can meet the qualifications to be a real estate professional.  Taxpayers that qualify as Real Estate professionals, are exempt from the general passive activity loss rules and allow losses to offset ordinary income.

Real Estate Professional Requirements

A person qualifies as a real estate professional if BOTH of the following requirements are met for the tax year:

• More than one-half of the personal services performed in trades or businesses by the person during such taxable year are performed in real property trades or businesses in which the person materially participates, and
• This person performs more than 750 hours of services during the taxable year in real property trades or businesses in which the person materially participates.

If a married couple is filing a joint return, at least one spouse must satisfy both requirements without reference to the services performed by the other spouse.  However, you can count your spouse’s participation in an activity in determining if you materially participated.

There are other rules, elections, court cases, and specific situations to consider in determining whether you qualify as a real estate professional.  Therefore, we highly recommend discussing your specific situation with your tax preparer to determine if you qualify