Rental losses are passive by default
Under IRC Section 469, rental activities are per se passive for most taxpayers. Passive losses can only offset passive income — generally income from other rental properties or passive business interests. They cannot directly offset wages, salary, or interest income. This means a W-2 employee who owns a rental and shows a $20,000 tax loss on Schedule E typically cannot deduct that loss against their paycheck in the current year. It is suspended and carries forward.
There are three ways out of this limitation, in order of increasing difficulty.
Path 1: the $25,000 active-participation allowance
If you actively participate in your rental (you make management decisions — approving tenants, deciding on repairs, setting rents — even if a manager handles day-to-day tasks), you may deduct up to $25,000 of rental losses per year against non-passive income. This allowance phases out between $100,000 and $150,000 of modified AGI — at $100,000 you get the full $25,000, at $125,000 you get $12,500, at $150,000 or above you get nothing.
Most moderate-income W-2 landlords with one or two properties qualify for this allowance. It is the most accessible path.
Paths 2 and 3: REPS and short-term rentals
Real Estate Professional Status (REPS) under Section 469(c)(7) removes the passive designation entirely for real estate activities if you spend more than 750 hours per year in real estate and real estate constitutes more than 50% of your total personal service hours. For a full-time W-2 employee who works 2,000 hours per year, qualifying for REPS means spending more than 2,000 hours in real estate — essentially impossible while employed full-time. REPS is primarily available to a non-working spouse.
Short-term rentals (average rental period of seven days or less) are not classified as rental activities under IRC 469 — they are treated as a business. If you materially participate in the STR activity (the simplest test is 500+ hours per year), the losses are non-passive and deduct against W-2 income with no MAGI phase-out.
Frequently asked questions
Can I deduct rental losses against my salary?
Generally no — rental losses are passive and cannot offset active (W-2) income. The exception is the $25,000 allowance for active participants with MAGI under $150,000, or REPS, or a short-term rental with material participation.
What happens to suspended rental losses?
They carry forward indefinitely. When you sell the property, all suspended passive losses are released and can offset the gain or any other income in the year of sale.
What is active participation in a rental?
Active participation requires making management decisions (approving tenants, deciding on major repairs, setting rent levels), but you can still use a property manager. It is a lower bar than material participation.
Sources
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.