Michael Henninger explains how rental losses can offset other income through two pathways: active participation allows up to $25,000 in deductions if your income is below $100,000, while material participation requires 750+ hours in real estate work and more than half your working time in the business. Real estate professionals can deduct larger losses if they meet IRS material participation tests.
Chapters
Today I wanted to go over a little bit of the concepts behind active and material participation, specifically as they pertain to losses generated by rental activities. As you heard me say many times, the losses generated from rentals are passive, and most of the time passive losses can only offset passive income. But there are some ways to unlock some of those losses and use them against your non-passive income. And one of those ways is if you actively participate In your rental activity. And active participation is a really low bar. It's basically, you know, you're choosing tenants, things like that. You're handling some of the management decisions, things like that. And then if you actively participate, you can deduct up to $25,000 of those losses against your non-passive income. But there are some income limitations. If you, once you hit $100,000, that $25,000 loss allowance gets phased out up until you hit $150,000, then it's gone. Another way is material participation, and that's often grouped, and it should be grouped with real estate professional status. And unfortunately, that real— the idea of real estate professional status is thrown around a lot as some easy door to walk through as a way to utilize passive losses against your non-passive income. It's really not as easy as some people are saying it is. It actually— you actually have to spend at least 750 hours in a real estate trade or business. It has to be more than 50% of whatever else you're doing. That means if you have, You know, if you're a dentist or a doctor or a lawyer or something and you have this other job, you're not going to meet that 50%, right? Additionally, you have to materially participate then in your rental activities. So it's those 2 things. You got 750 hours, 50% of what you do, and you have to materially participate in your rental activity. And what that means is there's 7 or so tests that the IRS says, hey, this is material participation. The usual 3 that people are able to meet are you had to spend 500+ hours materially participating, you have to spend more time than anybody else, or you spend 100 hours and that 100 hours is more than anybody else, right? So that's kind of the ways that you materially participate and hit those other real estate professional status criteria, the 750 and the 50% or more time spent doing anything. I just wanted to kind of briefly go over those things. There's a lot, there's caveats to anything with the IRS, so make sure you talk to a tax professional. Don't. run out and start doing things without making sure you're doing it with the T's crossed and I's dotted. Talk to a tax professional, make sure you kind of understand those things in detail. I just wanted to do like a 35,000-foot view of these ideas today. As always, I'm here if you want to talk, hit me up. Talk soon.
