Okay, I’m pretty sure I have an understanding of how you qualify as a real estate professional on your taxes; however, I have a question about what this really means. If someone meets the requirements to be considered a real estate professional, would they be able to deduct the actual mortgage payments?
For example, let’s say the 2009 numbers for a building you own broke down like this:
Now, if you file as a professional and make >150k a year, would you be able to deduct the $30,000 mortgage payment and just use the $20,000 net cashflow figure for your income taxes?
I’m a noob when it comes to this so I could definitely be off-base here, and I’d appreciate any help. Thanks!
You cannot use passive losses to offset earned income if your income is greater than 150K and you are not a RE professional. You can deduct deductible expenses against rental income every year and capture the losses when you sell the property.
In your example, you have a positive cash flow before taxes. If your depreciation expense is less than your cash flow, you will still have taxable income from your rental activity.
Whether or not you are a real estate professional and/or make more than $150K per year has no effect upon the taxability of your rental income.
You seem to have an incomplete understanding of how real estate expenses are treated for a rental property activity.
You deduct ALL of your legal rental expenses against the rental income the property generates, to include depreciation. If the bottom line is positive, then you have taxable income. If the bottom line is negative, then you are allowed to use up to $25K of your net passive rental loss to offset other ordinary income. This “net passive loss allowance” is phased out for incomes above $100K going to zero when income reaches $150K. At this point, your unused passive losses are suspended.
All is not lost. The suspended losses will still be there for you to use when the property starts showing profits or your income declines. And if there are still suspended losses sitting there when you sell the property, you will be able to offset the gain with these losses -– even if you sell the property at a loss – regarless of your income in the year of sale.
the ONLY difference being a “real estate professional” makes is that it removes the $25k passive loss cap.
However:
you must meet the 750 hours test for EACH ACTIVITY and EACH YEAR to be a real estate professional. This means each individual property.
If you don’t meet the test, then any losses >$25k will be suspended for that year.
If you group activities (ie: group all your rentals together) for the 750 hours test, then you can only take any prior suspended passive losses when the ENTIRE INTEREST is sold (ie: you sell the last of ALL the grouped properties). This gets complicated when you sell some and obtain new properties. It is very possible to get into a situation where you NEVER get the suspended passive losses out.
There are two requirements for a real estate professional. The first is that you must spend at least 750 hours per year in your real estate activity. The second is that the time spent in your real estate activity must exceed 50% of all the hours your spend in any activity.
I am guessing that your $150K annual income is derived from a salaried job that consumes at least 2080 hours per year (40 hours per week). Chances are that you will never be able to spend 2081 hours per year in your real estate activity to satisfy the 50% rule for real estate professional status.