Passive-Activity Loss Limits

Passive-activity losses:

• Are deductible, up to the amount of your passive-activity income
• Include losses from trade or business activities you don't materially participate in

Rental activities are always considered passive. That’s true unless you materially participate as a real estate professional. An activity is a rental activity if the income generated:

• Is mainly from the use of property
• Isn’t mainly from the performance of services

Special Allowance 

You might have passive-activity losses from rental real-estate activities you actively participate in. If so, you're allowed a special allowance of:

• $25,000 ($25,000) if you’re single or married filing jointly
• $12,500 ($12,500) if you’re married filing separately and lived apart all year

This allowance:

• Will be reduced by 50% of the amount of your modified adjusted gross income (AGI) that’s more than $100,000  -- $50,000 if married filing separately
• Can’t be used if your income is $150,000 or more -- $75,000 if married filing separately -- unless you have an exception claiming low-income housing credits

You actively participate in rental real-estate activities if both of these apply:

• You have a 10% or greater ownership interest throughout the year.
• You make management decisions, like:
  • Approving new tenants
  • Deciding on rental terms
  • Approving expenditures

From nonpassive income, you can deduct the lower of these:

• $25,000 -- or a reduced amount
• Net loss from active-participation rental real-estate activities

Losses are offset against passive income before figuring the amount allowed under this provision.

Ex: You have $5,000 in income from a limited partnership and $27,000 in losses from active participation in rental real estate activities. So, $5,000 of the loss offsets the passive income.

Depending upon your modified AGI, you might be able to deduct the other $22,000. The $25,000 limit is reduced by $1 for every $2 that your modified AGI is more than $100,000 . Under the $25,000 rule, you can’t claim losses when your modified AGI is $150,000 or more.

If you and your spouse file separate returns and you lived apart for the entire year, the limit is $12,500 . This begins to phase out when your modified AGI is more than $50,000 . If your modified AGI is $75,000 or more, you can’t claim losses. If you lived together at any time during the year, you also can’t claim losses.

Ex: If your modified AGI is $130,000, the $25,000 limit is reduced by $15,000:

[$130,000 (modified AGI) - $100,000 (income limit)] / 2 = $15,000 (reduction amount)

So, your loss deduction from rental real-estate activities with active participation is limited to $10,000:

$25,000 (deduction limit) - $15,000 (reduction amount) = $10,000 (loss deduction)

To learn more, see the Rentals and Royalties tax tip.