You should pay attention to passive loss rules before you can claim it, hoping to ‘dodge’ the tax bill. All real estate investors should familiarize themselves with information related to their investments, such as passive activity, passive loss, and even self-directed IRA
You wouldn’t be able to manage your investment in the proper manner if you are clueless about them. So, if you want to enjoy tax benefits or other perks in your investment, you should know many of the terms and concepts.
The Basic Definition
Passive (activity) loss rules basically don’t allow you to claim a tax reduction (or deduction) for losses related to a business or trade, especially the ones that you didn’t participate materially. You can find the rules under IRC (Internal Revenue Code) under Section 469.
According to both IRS and IRC, passive activity is the activity in which you aren’t actively involved within a business or a trade operation on continuous, substantial, and regular basis. In case your passive activity is experiencing losses, you can’t really claim the tax deduction. You are only able to claim the losses against the passive income coming from passive activity.
The IRS does provide a special allowance (up to $25,000) if the losses resulting from rental (real estate) activity, but it also depends on your MAGI (Modified Adjusted Gross Income).
Keep in mind that passive loss isn’t exactly an easy or simple matter. In fact, within the tax law, it’s quite complicated and complex. It’s advisable that you work together with a tax professional so you know whether you can claim the losses (on the tax return) or not – and what requirements you need to go through.
The Basic Things to Know
According to passive loss rules, you MUST take part in a business or trade (within an active manner) if you want to claim the loss.
This rule applies if you have a business, or even just a part of that business, like being a shareholder in a corporation or you are a partner within a partnership. The rule won’t apply to the corporation or partnership itself.
You should know that the passive (activity) loss rules would apply to:
- Closely held corporations
- Personal service corporations
- Trusts (beside grantor trusts)
The categories of passive activities are:
- You don’t exactly participate materially within the business
- The business incorporates real estate rent
Let’s say that you buy a house and then rent it out. It would be considered as a passive income. however, it won’t be considered a passive activity if you also qualify as the (real estate) professional, which means that you participate materially within the business.
How the Rules Work
According to IRC rules, you can claim active losses ONLY against active income (which you earn from participate actively within the business or operation).
And passive losses can be claimed ONLY against passive income. It means that you won’t be able to apply your passive (activity) losses to the active income if your passive losses exceed the passive income amount (from your passive activity).
Keep in mind that you are able to carry the passive losses (forward) to the future, so you can claim them against any future passive income, in the event they go beyond the passive income you get (from that current tax year).
The passive (activity) loss rules would apply until you basically dispose your interest of the activity. IRS lets you claim the unclaimed losses (in full) within the year you dispose the interest.
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It’s also possible that you would be considered eligible for the $25,000 allowance in the event the losses were coming from the activity of rental real estate.
According to IRS, you are able to subtract around $25,000 effectively, of the associated loss from the active income – if you participate actively in this activity type.
Asking for Help
As it was mentioned before, the calculation and arrangement for this can be complicated and even tricky. It would be so much wiser if you can ask for a help from the professional, especially tax expert or professional that can guide you through the process.
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The person won’t only help you understand the whole deal completely, but he/she can help you with the entire arrangement, especially related to passive loss rules. So by knowing passive loss rules in the term of real estate sale, you will know what should you do and what shouldn’t do. Hope these information can inspire you.