The Biggest Loophole to Deduct Real Estate Losses

The passive loss limitation levels for deducting rental real estate losses against other income hasn't been increased for inflation in over a decade. But for married couples there is a loophole that often will allow these expenses to be fully deductible, by qualifiying the other spouse as a "Real Estate Professional", and no, this does not mean the spouse must become a real estate agent.

How to Legally Deduct Real Estate Losses...

Who is considered a real estate professional?

Being a "Real Estate Professional" does not mean you are a real estate agent. Quite the contrary, most real estate agents would not be considered "Real Estate Professionals" via IRS rules. Why would you want to be a Real Estate Professional? When you meet those requirements suddenly all your passive losses in real estate are fully deductible against all other income. Normally passive losses from real estate investments are limited to $25,000 and the amount you can deduct goes down dollar for dollar every bit over $100,000 your AGI is at, meaning that most anyone who can afford to buy rental real estate can't take the deductions for these losses.

How then does one qualify as a real estate professional?

To qualify you have to meet two tests: You spend at least 750 hours per year on real estate investment activities, and that at least half of the personal services you perform is in real estate investment activities. Basically this means you can't have a full time job and call yourself a Real Estate Professional. But say you are married and one spouse works full time but the other one is laid off and collecting unemployment or a severance package- wouldn't this be a great time to spend all that extra time you have off fixing up your rentals, or looking to purchase more?

How do I prove this?

Keep a log or calendar of the hours you spend and it is easy to come up with 750 hours. An amazing amount of time normally goes into managing a property, even with property managers. Suddenly you have a huge deduction available- plus you get to write off all previously unallowed passive losses.

Can we do this if both spouses are employed?

Unfortunately, no. In order to be considered a real estate professional managing the rental properties must be the main activity and source of income for that person. Usually even a part-time job will disqualify someone from qualifying under this status.

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