Losses on Rental Property
When your expenses from a rental property exceed your rental income, your property produces a net loss. This situation often occurs when you have mortgage interest, depreciation deduction and cash expenses. The IRS has limit the loss deduction.
Passive Loss Rules
Property rental is a passive activity and subject to IRS passive activity loss rules. When you incur a real estate rental loss, the IRS considers the loss passive unless property management is your primary income-earning activity. You cannot deduct passive losses if you do not have any net income from your property rental for the tax year. Passive losses cannot reduce your income from wages, but you can defer the losses to future tax years or deduct any losses carried forward when selling the rental house that generated the loss.
Exception to Passive Loss Rule
The IRS allows a deduction of up to $25,000 for losses incurred on a rental property if you actively participated in the rental activity. In this case, the IRS will treat this as an active loss, which can reduce your other active income and consequently lower your tax bill.
“Active participation” means that you have significant participation in making management decisions or arranging for others to provide services. These management decisions might include approving new tenants, deciding on rental rates and terms, and approving capital or repair expenditures. However, you’re not considered to have “actively participated” if you own less than 10 percent of the property.