Although the word “loss” has a negative connotation, a passive loss in your real estate business can actually help you save money! In this post, we're talking about how passive loss can be beneficial when it comes to tax time.
A loss on your taxes means that your business did not make any money for the IRS to tax in a certain year. Claiming a loss is actually beneficial when tax time comes around, because then you don’t owe money! Many high earning investors like to claim a loss, in order to lower their overall tax burden.
Passive loss, however, only pertains to passive income. Luckily, real estate investing falls under this umbrella. Passive loss is anything in which the investor is not a material participant.
The tax law states that you can claim up to $25,000 as an individual if you have an adjusted gross income of $100,000 or less per year. From my experience speaking with hundreds of investors, the majority do not fall under this category.
But luckily, there are a couple exceptions to that rule:
Active Participation Exception - Any owner that spends some significant time on real estate investing. This doesn't mean you have to have a real estate license or be on site fixing toilets. Active participation could be helping your property manager review tenant applications, researching properties to purchase, or handling financing on your purchases. There is no hourly minimum for active participants. Typically, the IRS will be generous with this exception. This exception allows you up to $25,000 worth of loss during the year to be treated as an ordinary deduction.
Real Estate Professional Exception - This is the exception that we use in our business! This means that none of your real estate income and loss are subject to passive loss. You can qualify for this deduction if you spend more than 750 hours per year actively working in your real estate business.
If you want to learn more about passive loss and how it can help you in your real estate investing business, check out Garrett Sutton's book, the Loopholes of Real Estate!