What is the $25K passive loss exception?

The $25,000 passive loss exception is a tax rule that allows some taxpayers who actively participate in a rental real estate activity to deduct up to $25,000 of passive rental losses against non-passive (ordinary) income. This rule is particularly beneficial for taxpayers who don't qualify as real estate professionals but are still actively involved in their rental activities. Here's a breakdown of how this works:

Active Participation:

• Active participation is a less stringent standard than material participation and generally means you have a significant role in making management decisions, like approving new tenants, deciding on rental terms, and approving expenditures.
• You don't need to spend a specific number of hours participating in the activity to meet this criterion.

Income Limitations:

• The full $25,000 deduction is only available to those with a modified adjusted gross income (MAGI) of $100,000 or less.
• The deduction begins to phase out by $0.50 for every dollar your income exceeds $100,000.
• Once your MAGI reaches $150,000, the $25,000 passive loss exception is completely phased out, and you can no longer deduct passive rental losses against other types of income unless you have passive income to offset them.

Passive Losses:

• Passive losses typically come from rental activities or businesses in which you do not materially participate.
• If you can deduct losses under this exception, you're allowed to use up to $25,000 of losses from passive rental real estate activities to offset non-passive income, such as wages, salary, dividends, or interest.

Carryovers:

• If you can't use all of your passive losses in the current year because of the income limitation or because your losses exceed $25,000, the disallowed losses can be carried forward to offset passive income in future years.

Filing Status:

• The $25,000 passive activity loss allowance is only available to taxpayers who are actively participating and filing as Single or Married Filing Jointly. If you are Married Filing Separately and lived with your spouse at any time during the year, you generally cannot take the deduction.

Tax Forms:

• To claim this exception, you must provide details of your rental income and expenses on IRS Schedule E (Supplemental Income and Loss), and the passive activity loss limitations are calculated on Form 8582 (Passive Activity Loss Limitations).

Because tax laws can be complex and change over time, it's important to consult the latest IRS rules or a tax professional when planning your tax strategy related to rental real estate activities.