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Real Estate Tax Deductions: Active Participation & Real Estate Professionals

by Douglas Lineberry on September 2, 2005

Many people invest in real estate investment for potential tax advantages. In particular, it is possible to generate a tax loss through real estate when you do not actually have an economic loss.  This is true because when you add your depreciation deduction to all other cash-expense deductions, the deductions very often outweigh any income that a particular investment property might produce.

Are there limitations are on these deductions?  Yes.  Most importantly, for the vast majority of investors real estate rental will be deemed to be a passive activity.  Most taxpayers are therefore only allowed to deduct $25,000 of real estate losses against other income (and then only if the taxpayer “actively participates” in the rental activity).

There is a limited exception whereby “real estate professionals” do not have to treat real estate as a passive activity (and they are therefore not subject to the $25,000 passive loss limitation).  To qualify as a real estate professional, (1) more than one-half of your services performed in trades or business must involve real property trades or businesses in which you materially participate, and (2) you must perform more than 750 hours of service in those real property trades or businesses.

A real property trade or business is “any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.”

Note that you are also not allowed to count personal services as someone else’s employee under (1) and (2) above unless you own more than a 5% interest in the employer.  Therefore, working as the office manager of someone else’s real estate management business does not help you in satisfying the tests.

As with all tax matters, there are nuances and subtle points that have to be considered in every situation.  The above is only a very general discussion of the rules in this area.  If you need more information I encourage you to contact an attorney specializing in tax matters.

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