It’s tax filing season again and that means a lot of real estate investors are struggling with how to report real estate losses.
The sad fact is that real estate that you own and hold with a loss is a passive loss. At best, you participate in its management so you can claim a loss of up to $25,000 against your income if it’s less than $100,000 per year. If you make more than $150,000 per year, you’re out of luck. That is unless you materially participate (500 hours per year per property) and you are a real estate professional. It doesn’t end there though, you need to make a special election your tax return to claim the real estate professional status. And you can aggregate the properties so that you only have to do one stint of 500+ hours (instead of per house). You need to make a timely election to take the aggregation way out, though.
There is another technique that some are using that is wrong though. I’m actually seeing it more and more on tax returns I review for free. I’m not sure if it’s tax preparers that don’t understand the law, tax software that’s doing it wrong and no one is checking, or if it’s a bunch of people trying to get around the law. Here’s the problem - they are taking the real estate passive loss against active business income. You simply can’t do that. But they’re running it all through a Schedule E and, I think, netting it all together in hopes that it’ll sneak under the IRS radar.
I believe you should always set yourself up to pay the least amount of tax legally possible. But it has to be LEGAL! Something like this can cause excess tax, penalties and interest. Worse yet, let’s say you catch it on your return and your preparer corrects it on yours. He still might be doing it on others and that means he could be considered a targetted preparer. If the IRS sees he’s making a common mistake, every single one of his clients will get pulled into audit.
Be very careful here! If you’re interested in having me review your returns for free, please send them to our secure fax at 602.258.0721.
