How to Claim Real Estate Losses For Your Taxes
Introduction
In a recent episode of the tax strategy podcast hosted by Fujikawa & Associates, Josh, a real estate investor, and Derek, a CPA and real estate investor, delve into the nuances of active and passive income. This discussion is particularly relevant for professionals balancing a W2 job with investment pursuits, especially in real estate.
Key Takeaways:
1. Active income is earned through direct involvement in a job or business, while passive income is earned without active day-to-day involvement.
2. Real estate investments are classified as passive income by the IRS.
3. Active income losses can be deducted against other forms of income, while passive losses are more restricted.
4. Real Estate Professional status allows for the deduction of real estate losses against other income sources.
5. Depreciation in real estate allows investors to deduct the purchase price of a property over its useful life.
6. Short-term rentals can be considered active income if certain participation requirements are met.
7. Involving a non-working spouse in real estate activities can help offset W2 income with real estate losses.
8. Seek personalized advice for tax strategies based on individual situations.
Active Income Explained
Active income, as Derek describes, is earned through direct involvement in a job or business. This includes wages, salaries, and business income where there is active participation. The key characteristic of active income is the direct exchange of time and effort for money.
Passive Income: A Different Approach
Passive income differs significantly as it is earned without active day-to-day involvement. Real estate investments typically fall into this category. While some might argue that managing real estate requires active participation, the IRS classifies it as passive income. Other forms of passive income include earnings from stock dividends or other investments where the individual is not actively involved.
Tax Implications of Active and Passive Income
The taxation of active and passive income varies, especially regarding losses. Active income losses can be deducted against other forms of income, including W2, investment, or passive income. However, passive losses are more restricted. Under IRS rules, if your income is below $150,000, you can deduct up to $25,000 of passive losses against other income types.
Real Estate Professional Status
An interesting aspect discussed is the Real Estate Professional status, which can turn passive losses into active ones. To qualify, an individual must spend the majority of their time in real estate activities. This status allows for the deduction of real estate losses against other income sources, making it a powerful tax tool for eligible investors.
Depreciation in Real Estate
Derek explains the concept of depreciation in real estate, which, despite its name, is a tax benefit allowing investors to deduct the purchase price of a property over its useful life. This provision can lead to a scenario where an investor shows a loss for tax purposes while still earning positive cash flow.z
Short-term vs. Long-term Rentals
The classification of rental properties as short-term or long-term also affects their income categorization. Short-term rentals, defined as rentals with an average stay of seven days or less, can be considered active income if certain participation requirements are met, allowing for broader deduction opportunities.
Balancing Real Estate and W2 Income
For high-income professionals, balancing real estate investment with a W2 job can be complex. Derek suggests that involving a non-working spouse in real estate activities, potentially qualifying them as a real estate professional, can be advantageous for offsetting W2 income with real estate losses.
Closing Thoughts
Derek and Josh conclude the episode by emphasizing the importance of understanding the differences between active and passive income, and the impact of these categories on tax strategies. They encourage listeners to seek personalized advice for their unique situations.
