Then You Better Study and Pass all Your Tests
Generally, passive (rental) losses are ONLY deductible against income that you do not materially participate in, i.e., passive activity income. Losses that exceed your passive activity income are carried forward to the next year (indefinitely or until the related property is sold).
However, Real Estate Professionals can deduct their rental losses against nonpassive income such as wages or self-employment income. How do you become a Real Estate Professional? You must pass your tests.
Real Estate Professional Test
- More than half of the services you performed in the year were related to real property in which you materially participated, AND
- You performed more than 750 hours of real estate related services during the year in which you material participated. (See below.)
You must pass one of the following seven tests to qualify for material participation in each rental activity:
- You have more than 500 hours in the activity in the year.
- You provide substantially all the work in the activity. You don’t use others to provide repair, service, cleaning, or maintenance, etc. services.
- You spend more than 100 hours during the year on the activity and no one else provides more time.
- You spend over 100 hours during the year on the activity and you spend more than 500 hours on all similar activities.
- You materially participated in the activity for any five years during the last 10 years that immediately precede the tax year.
- You materially participated in a personal service business in any of three years prior to the tax year.
- Based on all the facts and circumstances, you participate in the activity on a regular, continuous, and substantial basis during the year.
You must qualify property by property unless you elect to treat all properties as one activity. If you want to deduct all of your rental losses and you don’t qualify for material participation (one of the seven tests above) for each property, then you should consider the one activity election.