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Line 23 of Schedule E cautions you that, for some people, real estate losses are limited regardless of the at-risk rules.
In contrast to the at-risk limitations, the passive activity loss rules apply to a larger group of taxpayers. They generally prevent taxpayers with adjusted gross income (AGI) above $100,000 ($50,000 if married filing separately) from deducting some or all losses from real estate rentals, other than the rental of your home that was also used for personal purposes.
There are two kinds of passive activities:
A real estate professional is one who spends more than 750 hours per year and more than half their working time in developing, managing, and/or selling real estate.
A rental activity is a passive activity even if you materially participated in that activity, unless you materially participated as a real estate professional. There are a few limited exceptions to the rule that a rental activity is a passive activity. Rental activity isn't a passive activity (and, therefore, is not subject to the passive activity loss rules) in the following cases:
Active Participation. "Active participation" means that you have significant participation in making management decisions or arranging for others to provide services. These management decisions might include approving new tenants, deciding on rental rates and terms, and approving capital or repair expenditures. However, you're not considered to have "actively participated" if you own less than 10 percent of the property.
"Modified AGI" means your AGI as shown on Form 1040, Line 37, without taking into account any passive activity losses, taxable Social Security benefits, deductible IRA contributions, the deduction for one-half the self-employment tax, and the exclusion for amounts received under an employer's adoption assistance program. Also, if you filed Form 8815, Exclusion of Interest from Qualified U.S. Savings Bonds, you must add back the savings bond interest excluded on Line 14 of that form.
Your losses may be limited if:
Generally, the rule is that you can deduct passive losses to the extent that you have passive income from other activities, and all rental real estate activities are treated as passive. See our discussion of which trade or business activities are treated as passive.
Special $25,000 allowance. Although all real estate losses are considered passive losses and, therefore, deductible only to the extent of passive activity income, there is a special break if you actively participated in the rental activity.
If you or your spouse actively participated in a passive rental real estate activity, you can deduct up to $25,000 of loss from the activity from your nonpassive income. Similarly, you can offset credits from the activity against the tax on up to $25,000 of nonpassive income after taking into account any losses allowed under this exception. If you are married and file a separate return, your losses are limited either to $12,500 if you lived apart from your spouse for the entire year, or to $0 if you lived with your spouse at any time during the year.
If you have more passive losses from real estate than you have passive income, your deduction of $25,000 will shrink as your AGI rises. You'll lose $1 of the deduction for every $2 that your AGI rises above $100,000; if your modified AGI is $150,000 or more, you can't deduct any excess passive losses this year.
If your losses are limited under any of these rules, you must complete Form 8582, Passive Activity Loss Limitations. The allowed loss, if any, shown on the bottom of Form 8582 is transferred to Line 23 of Schedule E.
Losses that cannot be deducted in the current year are carried over to later years until they can be offset by passive income, until you can use the special $25,000 deduction, or until you sell your entire interest in the property to an unrelated third party.