Rental real estate is passive by default
Under the passive activity loss (PAL) rules in IRC Section 469, rental activities are generally classified as passive regardless of how much time you spend managing them. Passive losses can only offset passive income — you cannot use a rental loss to offset your W-2 wages, business income, or interest without a specific exception. Losses that can't be used in the current year are suspended and carried forward to future years.
The $25,000 active participation exception
If you actively participate in your rental (make management decisions, approve tenants, set rents) and your modified AGI is $100,000 or below, you can deduct up to $25,000 of rental losses against non-passive income each year. This allowance phases out by 50 cents for every dollar of MAGI above $100,000 and disappears entirely at $150,000. The active participation standard is easier to meet than material participation — owning at least 10% of the property and having meaningful management involvement is typically sufficient.
Real estate professional exception
Investors who qualify as Real Estate Professionals (REPS) can treat rental activities as non-passive. REPS status requires: (1) more than 750 hours spent in real property trades or businesses in which you materially participate, and (2) those hours represent more than half your total work hours for the year. If you also materially participate in each specific rental property, the losses are non-passive and can offset any income. This is one of the most powerful tax strategies available to active real estate investors who can meet the hour requirements.
Frequently asked questions
Can I deduct rental losses against my W-2 wages?
Only through exceptions. The $25,000 active participation allowance phases out above $150,000 MAGI. The real estate professional exception can allow full deduction if you qualify.
What happens to suspended passive losses when I sell?
All suspended passive losses are released in the year you sell the property in a fully taxable transaction. They become ordinary deductions available against any income.
What is the $25,000 rental loss allowance?
An exception to the passive loss rules allowing up to $25,000 of rental losses to offset non-passive income for active participants with modified AGI up to $150,000 (full allowance below $100,000, phasing out above).
Sources
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.