For federal income tax purposes, the general rule is that rental real estate losses are considered passive activity losses (PALs). Generally, individual taxpayers can only deduct PALs to the extent they have passive income from other sources.
For instance, if you earn positive taxable income from other rental properties, that income typically counts as passive income. You can then use your rental real estate losses to offset that income, allowing for a current deduction.
What Happens to Disallowed Rental Real Estate Losses?
Many rental property owners have little or no passive income in a given year. In these cases, excess rental real estate losses (PALs that cannot be currently deducted) are suspended and carried forward to future years. You may eventually deduct these losses when you either:
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Generate enough passive income, or
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Sell the properties that produced the PALs.
Exception: Real Estate Professionals Can Deduct Rental Losses
There’s an important exception that allows qualifying individuals to treat rental real estate losses as non-passive. If you meet the criteria to be considered a real estate professional, you can generally deduct losses in the current year—even without passive income.
To qualify:
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You must spend more than 750 hours during the year delivering personal services in real estate trades or businesses in which you materially participate.
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These hours must account for more than half of your total personal service time during the year.
If you meet both requirements, the next step is to determine whether you materially participate in the specific rental activities.
How to Prove Material Participation
To treat rental real estate losses as non-passive under the real estate professional exception, you must pass at least one of these material participation tests:
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Spend more than 500 hours on the activity during the year.
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Spend more than 100 hours and more than any other person.
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Your participation comprises substantially all of the total hours spent by all individuals.
Passing any of these tests allows you to deduct current-year rental real estate losses as non-passive losses.
Other Exceptions That Allow Deducting Rental Real Estate Losses
If you don’t meet the real estate professional criteria, you might still qualify under one of these exceptions:
1. Small Landlord Exception
This rule allows taxpayers to deduct up to $25,000 of rental real estate losses as non-passive if they:
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Own at least 10% of the rental property, and
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Actively participate in its management (e.g., approving tenants or repairs).
This exception phases out between $100,000 and $150,000 of adjusted gross income (AGI) and does not apply to limited partnership interests.
2. Seven-Day Average Rental Period
If your property has an average rental period of seven days or less, it is treated as a business activity rather than a passive rental. If you materially participate, rental real estate losses from these short-term rentals can be deducted currently.
3. Thirty-Day Rental Period With Services
Properties with an average rental period of 30 days or less, where you provide significant personal services, may also be treated as business activities. Meeting a material participation test enables you to deduct these rental real estate losses as non-passive.
Maximize Your Rental Real Estate Tax Benefits
Various taxpayer-friendly provisions can make rental real estate losses deductible in the current year. Whether through real estate professional status, the small landlord exception, or short-term rental rules, there are strategies available to reduce your tax liability.
If you own rental property and want to make the most of your tax benefits, we can help you navigate the rules and apply the right strategy for your situation.
READ MORE: Determining if your property is a business or investment