Passive Activity Losses Related to Real Estate Activities

Generally speaking, passive activities result from a business activity in which you do not materially participate.  Any losses resulting from passive activities are limited to the extent of passive income.  You materially participate in a trade or business activity if you meet any of the tests listed below:

Tests to Determine if You Materially Participate in a Trade or Business Activity

  1. You participated in the activity for more than 500 hours
  2. Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who did not own any interest in the activity
  3. You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who did not own any interest in the activity) for the year
  4. The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours.  A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you did not materially participate under any of the material participation tests, other than this test.
  5. You materially participated in the activity (other than by meeting this fifth test) for any 5 (whether or not consecutive) of the 10 immediately preceding tax years
  6. The activity is a personal service activity in which you materially participated for any 3 (whether or not consecutive) preceding tax years.  An activity is a personal service activity if it involves the performance of personal services in the fields of health (including veterinary services), law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital is not a material income-producing factor.
  7. Based on all the facts and circumstances, you participated in the activity on a regular, continuous and substantial basis during the year.

How Passive Activities Relate to the Real Estate Industry

Real estate activities are unique in that they are, by definition, considered to be passive activities even if you do meet the material participation test.  An exception to this rule is met if you are a real estate professional.  You are considered a real estate professional if you meet both of the following requirements listed below:

Requirements to be Considered a Real Estate Professional

  1. More than half of the personal services you performed in all trades or businesses during the tax year were performed in real property trades or businesses in which you materially participated
  2. You performed more than 750 hours of services during the tax year in real property trades or businesses in which you materially participated

If you are unable to meet the material participation test and are not considered a real estate professional for real estate activity purposes, you are able to carry forward any disallowed passive activity losses to future years.  You may carry forward these suspended losses indefinitely until the activity has generated income to offset the losses or the activity is disposed of.  Any suspended losses that have been carried forward from prior years are fully deductible in the year of disposition if there is a “qualifying disposition,”.

Qualifying Disposition Requirements

  1. Disposition of an entire interest (or substantially all)
  2. In a fully taxable event (where all gain/loss is realized and recognized)
  3. To an unrelated party.

If you have any questions on passive activity losses and the real estate industry, contact the real estate professionals at Schneider Downs for further information.

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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

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