Real Estate Professional Exception to Passive Loss Rules

Life isn't exactly easy for most real estate brokers and agents these days. But real estate pros who own rental property have one thing going for them that others don't: special tax advantages.

Let's say that you are a rental property owner and you spend more on the property than you earn during the year–a depressingly common occurrence. Naturally, you'd like to be able to deduct your loss from any non-rental income you have, thereby reducing your taxable income and lowering your taxes for the year. Unfortunately, losses from real property rentals are classified as "passive activity losses." Special passive activity loss rules greatly limit the amount of losses that a rental property owner can deduct from his other non-passive income, such as salary or other business income. A maximum of $25,000 can be deducted from non-passive income each year, and even this is phased out if the owner's adjust gross income exceeds $100,000. Unused losses must be saved for future years.

Luckily for real estate professionals, they can qualify for a special exemption from the passive loss rules–an exemption nobody else can get. If you qualify, you may deduct any amount of rental activity losses you have for the year from your other income–such as real estate commission income–regardless of how high your income for the year may be. (IRC Sec. 469(c)(7).) For example, a real estate broker who loses $100,000 from his rentals could deduct the entire amount from his commission income.

But it gets even better. Real estate professionals are also not subject to the 3.8 percent net investment income tax on their real estate income. The NII tax was enacted to help fund Obamacare and took effect with the 2013 tax year. (However, real estate pros do have to pay the 3.8 percent tax on investment income, like interest and dividends.) So being a real estate professional can now save you on taxes whether your real estate ventures make or lose money.