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Rental Activities and Passive Limitations

This section includes a comprehensive guide to the IRS tax treatment of various rental activities. This information is important for landlords and renters alike. 

Rental reporting usually is handled on Schedule E of Form 1040 and rentals generally are passive activities. When it comes to real estate rentals, this is generally no problem. Some taxpayers’ deductible losses may be limited by the $25,000 loss rule (explained below). But certain “rentals” aren’t passive. The goal in this section is to determine the various kinds of rentals, how they are reported on a taxpayer’s return and what rentals are NOT covered by the passive rules. Some “rental activities” aren’t classed as rentals and certain activities belong on Schedule C. Others are reported directly on Schedule 1 of Form 1040 and still others can be classed as non-passive (under rules for real estate professionals).

In general, passive losses can be offset only by passive income and excess losses are suspended. However, there are exceptions to this rule:

  • Up to $25,000 in losses from certain rentals are allowed per year.
  • Upon total disposition of a passive activity all passive activity losses can be recognized. The passive rules apply to individuals, estates, trusts, and personal service corporations.

Overview

Passive Activity - Any trade or business activity in which the taxpayer “DOES NOT MATERIALLY PARTICIPATE” in actual operations of the activity on a “regular, continuous, and substantial basis” is passive.

Rental Activity – Is a passive activity (unless the rental isn’t really a rental, or the taxpayer qualifies as a real estate professional)

Limited Partnership Interest – is presumed passive (unless material participation standards are met).

Material Participation (Generally)

  • 500 hours or more;
  • Provides substantially all the participation; or
  • 100 hours and no one spends more time

Active Participation

  • Participates in management decisions
  • Generally, must have 10% or more of ownership
  • Does not apply to limited partners

Special Rental Real Estate Rule

  • $25,000 special loss allowance
  • Must show active participation
  • Allowance ratably phases out for AGI $100K to $150K

Reporting Schedules

  • Real Property – Schedule E
  • Personal Property – Schedule C
  • Transient Property – Schedule C

Unallowed Losses

  • Carry forward
  • Allowed in full for a total disposition (not a TFE)
  • Can offset other passive gains
Related IRC and IRS Publications and Forms
  • Pub 527 - Rental Activities
  • Pub 925 - Passive Activity & At-Risk Rules
  • Pub 946 – How to Depreciate Property
  • Form 4562 – Depreciation & Amortization
  • Form 4797 – Sale of Business Assets
  • Form 4835 - Farm Rental Income & Expenses
  • Form 8582 – Passive Activity Loss Limitations
  • Form 8582-CR – Passive Activity Credit Limitations
  • Schedule E – Supplemental Income & Loss
  • Sec 469 – Passive Losses

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