The IRS may deduct passive losses you incur each year from earned income up to the amount of rental real estate loss allowance. As long as you actively managed the property and earned less than $100,000 over the year, you can deduct up to $25,000 of your earned income by using this deduction. For instance, if you had earned $70,000 in salary and suffered a loss of $13,000 on your rental properties, you would be able to deduct $13,000 from the amount of money that you made.

After reaching an income of $100,000, the amount of your real estate loss that may be deducted begins to decrease, and this decrease will continue until it reaches a total of $150,000. If your MAGI is more than $150,000 (or $75,000 if you are married and filing separately), the Internal Revenue Service will not let you deduct any losses from rental properties. According to the Internal Revenue Service's definition of passive activities, there are two types:

• Activities in the commerce or business field in which you do not significantly engage throughout the year.
• Unless you are a licensed real estate agent, you cannot engage in rental operations, even if you significantly participate in them.

Your passive losses cannot, in most cases, be deducted from your adjusted gross income; rather, they can only be used to offset the passive income you have. On the other hand, the Internal Revenue Service creates an exemption for losses incurred through renting real estate and permits a deduction of up to $25,000 per year on passive and nonpassive or regular income (such as W-2 wages).

You are required to take an active role in the management of the property and owning rental real estate to qualify for the rental real estate loss allowance. According to the Internal Revenue Service's definition, active involvement requires owning more than 10% of the property and actively participating in management decisions throughout the year.

Calculating the number of allowed losses from passive activities that you may report each year requires using IRS form 8582. Real estate losses that cannot be utilized toward a deduction in a certain tax year are "suspended passive losses." These losses may be used toward a deduction in the year that follows the tax year in which they were suspended.

Working

In a perfect scenario, you would finance the acquisition of the real estate and then charge sufficient rent to cover the monthly costs of the mortgage and any other operating expenditures. However, some property owners end up losing money. This may happen, for instance, if their properties sit empty for long periods or if they invest a considerable amount of money in maintenance or improvements. When the revenue that property owners get from their rental real estate is less than the operational expenditures they have for their properties, this results in a loss for the property owners.

Consider the following scenario: you have a job in a different industry, own a few rental homes, and have an investment portfolio that brings in money. You have a property manager responsible for keeping track of the properties, but it is up to you to authorize new tenants and decide how much money should be spent.

After the year, you have earned $70,000 from your daily work and $15,000 from your investments. However, the actions related to your rental real estate properties caused you to lose $26,000. You are restricted to deducting a maximum of $25,000 in expenses. The remaining $11,000 of your loss might be used as a deduction against the income you get from your employment, while the first $15,000 could be used for the earnings of $15,000 in passive income from investments. For assistance in optimizing your deductions to your unique personal financial circumstances, you should seek the advice of a qualified tax counselor.

Conclusion

If you are not a real estate professional, you may be eligible to deduct rental real estate losses of up to $25,000 as long as you own 10% or more of the property and take part in managing it. This requirement must also be met to qualify. The rental real estate loss allowance may be used against either passive or active income, depending on the circumstances. You can lower earned revenue by using non-cash expenditures such as depreciation and financing charges such as interest expense. If your adjusted income is between $100,000 and $150,000, you will begin to lose the ability to deduct some of your losses.