Are there limitations on the tax losses I can write off on rental properties?

Yes, there are some important limitations on the tax losses you can write off on rental properties, particularly if the property is generating losses. These limitations depend on factors such as your income, the type of property, and whether you’re classified as a real estate professional under IRS rules.

Here are the main factors and limitations to keep in mind when it comes to writing off rental property losses:

1. Passive Activity Loss Rules

• Rental properties are typically classified as a passive activity by the IRS. This means you cannot fully deduct losses from rental properties against your non-passive income (such as wages or salary) unless certain exceptions apply.
• Passive activity losses are generally limited to the amount of passive income you have in a given year. So, if your rental properties are operating at a loss, you can only offset those losses against other passive income (e.g., income from other rental properties or passive investments like stocks).

2. The $25,000 Exception (Real Estate Loss Deduction)

• Special Rule for Active Rental Property Owners: If you are an active participant in the rental activity, you can deduct up to $25,000 in rental losses against your other income (such as wages, salary, etc.) each year, subject to certain income limits.
• Active Participation: You don’t have to be a full-time real estate professional to qualify for this exception, but you do need to be involved in decisions like approving tenants or managing repairs. It’s not enough to just be a passive investor; you must have a meaningful involvement in the management.
• Income Phase-Out: This $25,000 special allowance begins to phase out when your modified adjusted gross income (MAGI) exceeds $100,000. The allowance phases out completely when your MAGI reaches $150,000. For example:
  • If your MAGI is between $100,000 and $150,000, the deduction is gradually reduced.
  • If your MAGI is above $150,000, you cannot take advantage of this $25,000 loss deduction for rental properties.

3. Real Estate Professional Status

• Real Estate Professional Exception: If you qualify as a real estate professional under IRS rules, rental property income and losses are not subject to the passive activity loss rules. This means you can deduct your rental losses against your other non-passive income (such as wages, salary, etc.).
• To qualify as a real estate professional, you must meet both of the following requirements:
  • You must spend more than 750 hours per year in real estate activities (e.g., managing, renting, or developing property).
  • More than half of your working time must be spent on real estate activities. In other words, if you have a full-time job, the time spent on real estate must exceed the time spent on your job.
• If you qualify as a real estate professional, all your rental property income (even if it’s from passive rental activities) is considered non-passive. This means you can use rental property losses to offset active income, like wages or business income.

4. Depreciation and Carrying Forward Losses

• Depreciation: Rental properties are typically eligible for depreciation, which can significantly increase the losses you can write off each year. Depreciation allows you to deduct a portion of the cost of the property over time (usually over 27.5 years for residential rental property).
• Loss Carryforward: If you are unable to deduct your rental property losses in a given year (due to the passive activity loss rules or other limitations), you may be able to carry forward the losses to future years. This means you can apply the unused losses to offset future rental income or capital gains.

5. “At-Risk” Rules

• The at-risk rules further limit your ability to deduct rental losses. Under these rules, you can only deduct losses up to the amount you are “at risk” in the activity. For example, if you have borrowed money to finance the property, you are at risk for that debt.
• Your deductible losses may be limited if you’re using borrowed funds or if your equity in the property is minimal.

6. Short-Term Rental Properties (e.g., Airbnb)

• If you rent your property on a short-term basis (e.g., Airbnb), the IRS may treat the activity differently, depending on how much personal use you have and how much you rent it out.
• If you rent the property for fewer than 15 days per year, the rental income is generally not taxable, and you cannot deduct rental-related expenses.
• If you rent the property for more than 14 days, the rental activity is subject to the normal tax rules.  There may be additional requirements related to personal use that affect the deductions you can take.

If you fall into one of the aforementioned situations, it is important to keep up to date on the limitations on tax losses that can be written off for rental properties.