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A Possible Way to Deduct Real Estate Losses

Rental Real Estate is just about my most favorite recommendation for investment (even ahead of stocks and bonds). It usually generates enough cash flow to break even if you must use a substantial mortgage to purchase it initially. Even better, with depreciation expense, it can create a tax loss that reduces your tax on other income. It appreciates in value over the years and when you eventually sell it, after paying normal tax on the amount of depreciation taken over the years, the rest is taxed at Capital Gains rates. If you choose to use a professional property manager, about the only negative to owning rentals goes away. (Pesky phone calls in the middle of the night because the water heater went out, etc.)

There’s a catch. Most folks who own rentals are higher income taxpayers. In the tax law, they usually are not allowed to deduct rental losses, only accumulate them to reduce the taxable gain when sell someday or reduce taxable income in years when it has a rental operations profit.

The way to deduct all those lovely rental losses each year is to be classified as a “Real Estate Professional” by the IRS. You do NOT have to be in the business of selling real estate, or even be a Real Estate Agent. The IRS defines a “Real Estate Professional” as someone who materially participates in the activity.

The IRS has created a simple to understand process to see if you can qualify as a “Real Estate Professional.” FIRST: You must show that you spent more than half of the personal services performed by you during the year on real property trades or businesses in which you materially participated in. SECOND: You must demonstrate that you spent at least 750 hours on real property trades or businesses that you materially participated in.

Let me make this clear. If the taxpayer or the taxpayer’s spouse, if married filing jointly, devotes more than half their time to real estate investments and more than 750 hours in the activity, the “material participation” requirement will be met.

Did you get that? In a married filing joint return, both spouses benefit from the full deduction of rental losses if only one of them qualifies as a “Real Estate Professional.”

IRS requires that the “Real Estate Professional” keep a log or diary of their hours and services performed during the year to prove they spent at least 750 hours on real property trades or businesses. Anything you do related to your real estate counts. So, document it or the IRS will reject the status in an audit.

Have you heard? Proverbs 14:23 says, “In all hard work there is profit, but the talk on the lips leads only to poverty.”

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