Real Estate
Rules around deducting passive losses for real estate.
In order to qualify as a real estate professional, you must spend at least 750 hours in a real estate trade or business and more than half your total working hours must be in a real estate trade or business. Due to these requirements, many investors who work a full-time job or full-time in another business not real estate-related will have a hard time qualifying as a real estate professional.
That said, simply meeting the above requirements will not necessarily allow you to deduct your rental losses against your ordinary income. You must also materially participate in the rental activity using the tests mentioned below. But it is most commonly done by electing to aggregate all your rental properties as one activity and then working 500 or more hours in this single activity per year.
You participated in the activity for more than 500 hours.
Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who didn’t own any interest in the activity.
You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who didn’t own any interest in the activity) for the year.
The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you didn’t materially participate under any of the material participation tests, other than this test.
You materially participated in the activity (other than by meeting this fifth test) for any 5 (whether or not consecutive) of the 10 immediately preceding tax years.
The activity is a personal service activity in which you materially participated for any 3 (whether or not consecutive) preceding tax years. An activity is a personal service activity if it involves the performance of personal services in the fields of health (including veterinary services), law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital isn’t a material income-producing factor.
Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the year.
If one spouse qualifies for the 750-hour test, both spouses’ time on the rental properties count toward material participation, and losses can then be taken against either spouse’s income. This is a great strategy for couples where one spouse works in a real estate trade or business, works only part-time, or not at all outside of your investment activities.
In any year you elect to be treated as a real estate professional for tax purposes, you’ll need to keep a log of all hours worked within a real estate trade or business. It is also prudent to keep a log of hours spent in non-real estate trades or businesses, if applicable to ensure you’re spending more than half your total working time in a real estate trade or business.