Realty411 Magazine Featuring Lori Greymont

Dealer VS Real Estate Professional Deductions By Patrick James, United States Tax Relief such losses for many years. In short, your rental losses will be useless without offsetting passive income. I f the IRS audits a real estate investor, one of the first things they look for is whether the investor is a dealer or a real estate professional. Most dealers are subject to passive activity loss rules that limit the amount of losses from negative – cashflow real estate. If however, the IRS designates you as a real estate pro- fessional, you get to write off unlimited losses against income! RENTAL LOSSES FOR DEALERS Here’s the basic rule about rental losses you need to know: Rental losses are always classified as “passive losses” for tax purposes. This greatly limits your ability to deduct them because passive losses can only be used to offset passive income. They can’t be deducted from income you earn from a job or investments such as stock or savings accounts. Passive income is the income you earn from rental real estate or other passive activities. An activity other than real estate is considered passive if you don’t “mate- rially participate” in it – that is, work at it for a minimum number of hours each year – usually 750 hours. Passive income does not include income from a job, a business you actively manage, or investment income. Thus, for example, you’d have passive income if you earn a profit from one or more rentals. Without passive income, your rental losses become suspended losses you can’t deduct until you have suffi- cient passive income in a future year or sell the property to an unrelated party. You may not be able to deduct Realty411Guide.com EXCEPTIONS TO PASSIVE LOSS RULES There are only two exceptions to the passive loss (“PAL”) rules: • You or your spouse qualify as a real estate professional, or • Your income is small enough that you can use the $25,000 annual rental loss allowance. • Property owners with modified adjusted gross incomes of $100,000 or less may deduct up to $25,000 in rental real estate losses per year if they “actively participate” in the rental activ- ity. You actively participate if you are involved in meaningful management decisions regarding the rental property and have more than a 10% ownership interest in the property. This allowance is phased out for taxpayers whose MAGI exceeds $100,000 and eliminated entirely when it exceeds $150,000. Thus, it is useless for high-income landlords. So what does the IRS look for to determine if you are a real estate dealer or real estate professional? It all depends on how you spend your time. TO BE A REAL ESTATE PROFESSIONAL To be a real estate professional, you need spend at least 750 hours each year actively working in your real estate business – AND you must pass what the IRS calls the “half-personal services test.” This means you must spend MORE than 50% of your working time in your real estate business. Per the IRS, “If the taxpayer has a full-time job working 2,080 hours a year in a non-real property business, he must work 2,081 on his real property businesses to meet half-per- sonal services test.” The 750 hour test must be met by one spouse alone so don’t say, “My wife and I both work the real estate business, and between the two of us, we put over a thousand hours into the real estate business.” – you will loose. The IRS is very PAGE 14 • 2015 Continued on pg. 16 reWEALTHmag.com

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