Understanding The $25,000 Special Allowance

If you have active income from salaries, wages, business income, you can offset up to $25,000 of your ordinary income from losses in real estate. This is known as the Special $25k allowance.

Losses from real estate are termed as passive losses, btw.

To take the $25k allowance, you and your spouse or if you are single; you would have to ‘actively participate’ in the passive rental estate rental activity. Active participation is considered different from material participation as per the IRS.

Active participation is a less stringent than material participation. The IRS says, “You may be treated as actively participating if you make management decisions in a significant and bona fide sense. Management decisions that count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and similar decisions.”

e.g. Limited partners (LPs) aren’t treated as actively participating in a partnership’s rental real estate activities (as in the case of LPs for Syndications).

Ok, so continuing with the maximum special allowance (of $25,000): It’s reduced if your modified adjusted gross income (MAGI) exceeds certain amounts. Let’s see what those amounts are.

The Phase Out Rule (I’ve made it simple for you!)

If MAGI < $100,000 (if MFJ) – You get the special $25k allowance. Great!

If $100K > MAGI < $150k (for MFJ): the allowance starts to phase out and gets reduced by 50% of the amount of your MAGI that’s more than $100,000.

If your MAGI> $150,000 or more, you can’t use the special allowance. (Sorry, it’s not for everyone!)

Example:

Katie, a single taxpayer, has $80,000 in wages, $15,000 income from a limited partnership, a $26,000 loss from rental real estate activities in which she actively participated, and isn’t subject to the MAGI phaseout rule. She can use $15,000 of her $26,000 loss to offset her $15,000 passive income from the partnership. She actively participated in her rental real estate activities, so she can use the remaining $11,000 rental real estate loss to offset $11,000 of her non passive income (wages).

Q. What if there was just the $26k in losses from rental real estate and no LP income in the above example?

A: In that case, Katie would have used the $25,000 maximum special allowance to offset against her ordinary income of $80,000 for that year. The remaining $1,000 rental losses would be carried forward to next year.

Useful tip:

  • Be careful if you have a property management company taking care of your rental, be sure that you are still involved at some level to be ‘actively participating’ in your rentals and while claiming the $25k special allowance.

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