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Tax Deductions on Rental Properties Until the mid-80’s, just about anyone could deduct in full all losses from real estate rentals against their business or investment income to save on taxes. In 1986, the Reagan Administration slashed both taxes and tax shelters. Since then, rental losses from real estate have usually been considered "passive losses" which ordinarily cannot be used to cut taxes on business and investment income. Instead, rental losses could only be used to offset rental income. In 1993, the Clinton Administration hiked taxes and also created an exception to the passive loss rules. Under that exception, rental real estate is no longer considered a passive activity if the landlord "materially participates" in the rental and performs "qualifying services in real property trades or businesses." In that case, a landlord is considered a “qualified real estate professional,” and can deduct rental losses against business and investment income. A real property trade or business is any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business. Homebuilders, developers and construction contractors are all included in this definition. To be a “qualified real estate professional”, you must spend more than half your working time, and no less than 750 hours per year, “materially participating” in the real estate business (not just as a passive investor). On a joint return, you meet this requirement if either spouse separately satisfies the requirement. The time requirement can be satisfied by any reasonable method, including but not limited to payroll records, appointment books, and calendars. There are a few twists to the rules. If you own a condo, for example, where you are not active as the landlord (for example, you might have a leasing agent or management company involved), that rental is treated as passive, and you cannot claim that loss against business/investment income. Also if you own less than a 10% interest in a rental property, you are likewise presumed not to be actively involved and may not claim the loss. You are, however, permitted to use an eligible rental property personally for up to 14 days per year and still deduct 100% of your rental loss. And days you use the property for cleaning, maintenance, renovations, etc. do not count toward that number. This all means that a construction contractor, homebuilder, or developer can get huge tax benefits from rental real estate that are unavailable to landlords who spend most of their time working in other fields (such as doctors or owners of manufacturing companies). As a result, rental real estate can be a good component of a wealth-building plan because it can generate tax savings and cash flow while building wealth in the form of property appreciation. If you are concerned about whether or not you satisfy all of the requirements to obtain tax benefits from rental real estate, please contact us and we will be happy to look at how to best position you to get these tax savings. Large & Gilbert, P.C. |
