Dear Tax Talk,
I make more than $150,000, so I cannot deduct up to $25,000 on real estate losses. I can carry those losses over. Say next year I make $90,000. Will I be eligible to deduct $25,000 plus the loss from the previous year — for example, $10,000? So, in total, $35,000?
— Roshenda

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Dear Roshenda,
The passive activity loss rules will limit your deduction to $25,000 rather than the $35,000. However, all is not lost as you will still be able to continue to carry the losses forward until you are able to deduct them on future returns.

Rental property is considered to be a “passive activity” for tax purposes and subject to special rules regarding deducting losses. The general rule is that “passive losses” can only be used to offset “passive income,” which means they cannot be used as a deduction against earned income — for example, income from your job, stock dividends or interest income.

The deductions are not lost forever. Rather, they are suspended and carried forward until such time as you have passive income or the property is sold.

There are 2 exceptions to the general rule, and this is where you are looking for some relief.

2 exceptions to passive income rule

  • The 1st exception is if you or your spouse qualifies as a “real estate professional.” This is not your situation, so we will go to the next exception.
  • The 2nd exception allows up to $25,000 of rental real estate losses to be deducted from your income if your modified adjusted gross income, or MAGI, is $100,000 or less. The allowance is phased out once your MAGI is over that amount and completely eliminated once your MAGI is greater than $150,000.
  • There is a caveat to the 2nd exception: You have to “actively participate” in the rental activity by owning at least a 10% interest and by being involved in making management decisions for the property.

The IRS has thought ahead to help you calculate and keep track of these losses. Each year you need to complete Form 8582, Passive Activity Loss Limitations. On that form you will input your “prior year unallowed losses.” It also helps with the calculation of the current year loss allowed, so be sure to take a look at this form along with the instructions as there is a lot of information for you to learn regarding your rental property.

Thanks for the great question and all the best to you.

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