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Leslie Daff, JD, MBA - Orange County Estate Planning Lawyer

Friday, February 10, 2012

Tax & Estate Planning Tip #8: Maximize the Tax Benefits from Your Rental Property

If you have real estate you rent to others, losses from those rentals can provide a tax shelter, but the losses are often limited by the “passive activity loss” rules.  In short, the passive loss rules stop you from using losses from tax shelters to reduce your income from wages, self-employment income, interest, and dividends. 

To illustrate, assume Chris has $100,000 of wage income, $10,000 from a natural gas limited partnership (Passive Investment 1), and $30,000 of loss from a rental home (Passive Investment 2).  Chris’s desired income is for income tax reporting purposes is $80,000 ($100 + 10 - 30).  Instead Chris must report income of $100,000 ($100 + 10 – 10).  The extra $20,000 of loss from the rental is postponed until Chris has more passive income or sells the rental home.  However, there are three exceptions (opportunities) that would allow Chris to report the desired $80,000 of income. 

First, Chris could use the “middle class rental real estate” exception that allows owners to deduct $25,000 of rental real estate loss if the owner owns more than 10% of the rental property and the owner is actively involved in the rental, meaning he or she approve new tenants, sets the rental terms, collects checks, and oversees repairs. This exception is not available when the owner’s total income exceeds $150,000. 

A second way for Chris to deduct the rental real estate losses is to obtain a real estate license and use the “real estate professional” exception.  To qualify as a real estate professional, the owner must work more than half time and at least 750 hours per year in real estate businesses.

A third way for Chris to report the desired income of $80,000 is to qualify for the “significant personal services” exception.  If an owner rents his or her property for more than 30 days on average and provides significant personal services for tenants (gardening, housekeeping, sightseeing suggestions, transportation), the owner can deduct losses if he or she is actively involved in the real estate business, meaning the owner (and his or her spouse’s) involvement is more than 100 hours and no one is more involved than the owner and his or her spouse

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