Think You Can’t Deduct Real Estate Losses? You Might Be Wrong.
Many real estate investors—especially high-income earners—miss out on valuable tax deductions simply because they’re misclassified under IRS rules. Are you passive, active, or a real estate professional? The answer can make a six-figure difference in your tax bill.
At Gulla CPA, we help investors properly structure their real estate activity so they can maximize deductions and minimize audit risk. Here’s what every property owner needs to know.
Passive Real Estate Activity
By default, all rental real estate activity is considered passive, even if you’re actively involved.
Definition:
Passive activities are those in which the taxpayer does not materially participate. The IRS assumes rental activity is passive unless an exception applies.
Key Features:
- Loss Deduction: Only offsets passive income (e.g., from other rentals or K-1s)
- Carryover: Unused losses carry forward indefinitely
- $25,000 Exception: If AGI is below $100,000 and the taxpayer is actively participating, they can deduct up to $25,000 against ordinary income
- Phase-Out: This allowance is phased out by 50% of AGI over $100,000 and completely phased out at $150,000
This classification often limits higher-income investors from using rental losses against W-2 or business income.
Active Participation
This is a middle-ground classification with relaxed participation rules and limited benefits.
To Qualify:
- You must own at least 10% of the rental property (directly or indirectly)
- You must make key management decisions (e.g., approving tenants, authorizing repairs)
Tax Benefit:
- Unlocks the $25,000 special allowance for deducting losses against ordinary income (if AGI is under $150,000)
While less restrictive than material participation, this option is not viable for high-income taxpayers due to the AGI limitation.
Real Estate Professional Status (REPS)
This is the most powerful classification, especially for those with significant real estate holdings or income.
IRS Requirements (IRC §469(c)(7)):
- More than 50% of your personal services for the year must be in real property trades or businesses
- You must work at least 750 hours annually in real property trades or businesses
- You must materially participate in each rental activity (or elect to group them under Reg. §1.469-9(g))
Eligible Real Estate Activities:
- Development, redevelopment
- Construction, reconstruction
- Acquisition or conversion
- Rental or leasing
- Operation, management, or brokerage services
Tax Benefit:
- Rental real estate losses become fully deductible, even against W-2 wages or business income
- No AGI limitation applies
Documentation Required:
- Contemporaneous time logs showing dates, hours, and activities
- Proof of material participation, such as 500+ hours per property or doing substantially all of the work
Comparative Summary Table
| Feature | Passive Activity | Active Participation | Real Estate Professional (REPS) |
| Default for Rental Properties | ✅ Yes | ✅ Yes (with more involvement) | ❌ No (must qualify) |
| Loss Deduction | Offsets only passive income | Up to $25k against ordinary income (AGI < $150k) | Fully deductible against ordinary income |
| Participation Required | ❌ None or minimal | ✅ 10% ownership + decision-making | ✅ 750+ hours + >50% of work in real estate |
| Material Participation Needed | ❌ No | ❌ No | ✅ Yes (or grouping election under §1.469-9(g)) |
| Documentation Level | Low | Moderate | High (logs and detailed records) |
| Common Use Case | Casual landlords | Small landlords with day jobs | Full-time real estate investors or agents |
Key Planning Considerations
✅ Income Over $150,000?
You won’t benefit from the $25,000 allowance unless you qualify as a real estate professional.
✅ Own Multiple Properties?
Consider a grouping election under Reg. §1.469-9(g) to meet participation thresholds across properties.
✅ Audit Risk?
The IRS actively scrutinizes REPS claims—detailed time tracking is essential to support your position.
✅ Passive Loss Carryforwards?
Strategically timing REPS qualification can help unlock years of suspended passive losses.
What to Do Next
If you’re unsure where you fall—or want to make sure you’re maximizing your tax position:
- Determine your AGI and current passive loss situation
- Log your real estate hours (if you’re active in the business)
- Evaluate grouping elections if you manage multiple properties
- Schedule a tax planning consultation with a Gulla CPA advisor
Need Help Structuring Your Real Estate Tax Strategy?
Whether you’re a casual landlord, a full-time investor, or a real estate agent managing your own portfolio—your classification under the IRS code can make or break your tax return.
📩 Contact Gulla CPA today to ensure you’re not leaving valuable deductions on the table.
