Real
Estate Rental Activities Exception
a/k/a
"Active Participant Exception"
This exception to passive loss rules allows an individual to offset against active and portfolio income up to $25,000 per year in passive losses from real estate rental activities. (See phase-out rules below.)
The loss from a real estate rental activity must first be netted against gains from the taxpayer's other passive activities (real estate rental and others). In other words, this exception comes into play only if the taxpayer has a net passive activity loss, and that loss was generated by a real estate rental activity.
To qualify for this exception, the taxpayer must:
Be
an "active participant" in
the real estate rental activity, and
To be an "active participant" the taxpayer must have a "significant and bona fide involvement" in the real estate rental activity. A "significant and bona fide involvement" exists when the taxpayer is regularly involved in some significant aspect of the rental activity, such as arranging financing, collecting rents, approving tenant-applicants, arranging or performing repairs and maintenance, keeping records, etc. About the only way a rental owner would not qualify as an "active participant" is by turning all management activities over to a hired manager. A taxpayer who retained only the power (which he actually exercised) to approve or reject a tenant-applicant chosen by the hired manager was found to be an active participant.
If a taxpayer qualifies for tax credits with respect to the loss-producing real estate rental activity, the credit must be aggregated with the loss on a "deduction equivalent" basis, which can be rather complicated. The effective result is that the taxpayer takes the credit and the $25,000 (or lesser) amount otherwise allowed is reduced by an amount equal to the tax credit taken times the taxpayer's marginal tax rate.
The $25,000 offset allowance is phased out for higher-income taxpayers. The $25,000 amount is reduced by 50% of the taxpayer's "adjusted AGI" in excess of $100,000. Thus it is effectively eliminated for taxpayers with $150,000 or more of "adjusted AGI".
The term "adjusted AGI" is used here because for the purpose of this phase out, AGI is calculated without regard to IRA dedutions, Social Security benefits, interest deductions on educational loans, and net [allowable] losses from passive activities.