If you rent buildings, rooms, or apartments, and provide basic services such as heat and light, trash collection, etc., you normally report your rental income and expenses on Schedule E. But, did you know that your deductions and losses are limited?
You generally can’t offset income, other than passive income (in this case rental income), with losses from passive activities. Nor can you offset taxes on income, other than passive income, with credits resulting from passive activities. In addition, your passive income maybe subject to an additional 3.8% Net investment Income Tax.
For Instance, if you have one or multiple rental properties that had major updates and not rented the full year, with net loss of $20,000, and you had another income from W2 for $50,000, you cannot offset the $20,000 rental loss (passive loss) against your earned income (W2 income). Your loss will be subject to the At-Risk and Passive Activities loss Limitations rules. However, excess loss can be carried forward to the next tax year.
Here is the good news, If you qualify for a “Real Estate Professional” status, rental real estate activities in which you materially participated aren’t passive activities, and hence, rental loss can be offset against other income and reduce your taxes.
Real Estate Professional status is very beneficial for those who are in the business of residential real estate rentals. Under IRC Sec. 469(c)(7)(B), and in order to be considered a “Real Estate Professional”, you must meet both of the following requirements:
- More than half of the personal services you perform in all trades or businesses during the tax year are performed in real property trades or businesses in which you materially participate.
- You perform more than 750 hours of services during the tax year in real property trades or businesses in which you materially participate.
The IRS will treat each property separately, so a real estate professional generally must establish material participation and 750 hours rules in each rental activity separately, which is a deal breaker! Ask us how you can make an election to aggregate all your rental interests and treat all your rental properties as one.
Real estate professional status has nothing to do with the real estate license agent. In other words, you don’t have to be a real estate licensed agent to qualify for real estate professional status and being a real estate agent does not automatically qualify you.
Understanding “Materially Participation” and “Actively Participation” requirements, elect to aggregate all your rental interest as one, and utilizing the safe harbor rule will help optimize your investment income and increase your net profit.
If your tax advisor didn’t discuss these matters with you before, it’s maybe a good sign to look for a new one. We, at Taxville Financial, take tax preparation and tax planning to the next level.
We take a consultative approach to help you make informative decisions. When you come to file your business taxes, we most likely cannot change the past (In some cases we can!!) but, we will provide you with the tax advice and guidance to optimize your business and keep more of what you earn.