Barry Dolowich, Tax Tips: Passive loss rules

Question: I just received our 2022 tax returns from our preparer which are on Disaster Relief extension. We were shocked to discover that our large rental loss we incurred during 2022 due to vacancy and high repairs provided us with no tax benefit. Our tax preparer told us that none of our rental loss was deductible in 2022 and that the losses would be carried forward. I am so confused! What are the rules for deducting rental losses?

Answer: Generally, rental real estate is considered a passive activity. Passive losses are only deductible to the extent you have passive income. In other words, you can offset your passive income with passive losses. Unused passive losses are carried forward until you have passive income to offset or you dispose of the passive activity freeing up that activity’s passive loss for a deduction.

However, there is a limited exception to the passive activity loss rules for rental real estate in which the taxpayer actively participates. An individual may meet the “active participation” requirement by participating in the management decisions (i.e. approving tenants, collecting rents, providing services, etc.) in a significant and bona fide sense. This exception allows a deductible loss of up to $25,000. To be eligible for this exception, you must own at least a 10% interest of all interests in the activity throughout the year.

The $25,000 maximum amount is reduced, but not below zero, by 50% of the amount by which your adjusted gross income exceeds $100,000. Therefore, the $25,000 is completely phased out when modified adjusted gross income reaches $150,000.

I suspect your modified adjusted gross income was above $150,000 last year creating a total phase-out of your active participation rental loss. Your unused 2022 rental losses should be carried forward to a time when you have qualified passive income to offset or you dispose of the property.

Please note that there are special rules for real estate professionals. Also, the deductibility of rental losses may further be affected by “at risk” rules.

Barry Dolowich is a certified public accountant and owner of a full-service accounting and tax practice with offices in Monterey. He can be reached at 831-372-7200. Please address any questions to Barry at PO Box 710 Monterey, CA 93942 or email:[email protected]