Writing off losses on an apartment building

Dear Tax Talk,
I used a 1031 property exchange to acquire a multiunit apartment investment in 1999. I went into title as an individual and immediately quitclaimed it over to the LLC. In 2003, we took a beating and had to feed the investment. My portion of the loss was sizable, but I was told that due to my income bracket I wouldn't get to apply the loss against my income. My tax preparer said I would get to use it since my wife, who is also in the LLC on the subject property, is a real estate agent and we could claim the loss because we would be interpreted as dealers. I have filed an extension so I have time to get an answer on this issue. If the Internal Revenue Service lets this go through, will I jeopardize my 1031 status and be exposed to a capital gain when I sell the property? -- Tom

Dear Tom,
If I, as a preparer, tell a client that they can claim a deduction on their tax return, they usually accept that and are happy. You, on the other hand, seem to doubt what your return preparer is telling you. If you lack confidence in your return preparer by questioning what he's telling you, maybe he's not the right person to have preparing your taxes.

Based on what you're telling me, you should be able to deduct the losses from the rental property. For most folks, losses from rental activities such as the multiunit apartment investment are passive losses and are not deductible against ordinary income. An exception to this rule is if your adjusted gross income is less than $150,000. In that case, you can deduct part of the losses of rental properties you actively participate in. The deduction is up to $25,000 in passive losses when your adjusted gross income is below $100,000 and when your AGI is between $100,000 and $150,000 the $25,000 maximum is reduced $2 for every $1 your AGI exceeds $100,000.

Another exception exists for real estate professionals, which is what you refer to as dealers. In the case of a husband and wife, if either is considered a real estate professional, passive losses from rental activities are not subject to loss limitations. A real estate professional is a person who devotes more than half of all his working time to the real estate profession (i.e., developer, agent or broker) and that half exceeds 750 hours annually.

Classification as a real estate professional would not in itself jeopardize the benefit of the lower long-term capital gains rates or the ability to do Section 1031 exchanges. Those limitations generally only apply to developers.