Quick answer: Rental activities are generally treated as passive, so rental losses can usually offset only passive income, with unused losses carried forward until you have passive income or sell the property. Many owners who actively participate in managing their rentals can deduct up to $25,000 of rental losses against other income, but that allowance phases out as modified adjusted gross income rises above $100,000 and is gone at $150,000. Taxpayers who qualify as real estate professionals and materially participate in their rentals can treat those losses as nonpassive.
Landlords are often surprised to learn that a rental showing a tax loss, thanks largely to depreciation, does not necessarily reduce their tax bill. The passive activity rules were written to stop people from using real estate losses to shelter wages and business income. Having owned rentals while working full time ourselves, we understand how frustrating these rules can be. Here is how they work.
What makes rental income passive
Under the tax code, a passive activity is a trade or business in which you do not materially participate, plus nearly all rental activities, regardless of how much work you put in. That second part is the key point: rental real estate is treated as passive by default.
The practical result is that losses from passive activities can generally offset only income from passive activities. If your rentals lose money and you have no other passive income, the losses are suspended and carried forward to future years. The calculation is done on Form 8582.
Some short-term rental arrangements, where the average guest stay is seven days or less, are not considered rental activities under these rules and follow different tests. That is a topic of its own.
The active participation allowance
Congress carved out relief for ordinary landlords. If you actively participate in a rental real estate activity, you may be able to deduct up to $25,000 of rental losses against nonpassive income such as wages, pensions, or business income.
Active participation is a modest standard. It generally means you own at least 10 percent of the property and take part in management decisions in a meaningful way, such as approving tenants, setting rents, and approving repairs. Using a property manager does not automatically disqualify you, as long as you make the significant decisions.
The allowance phases out as your modified adjusted gross income rises. It is reduced by 50 cents for every dollar above $100,000 and disappears completely at $150,000. These thresholds are set in the statute and have not been indexed for inflation. Married individuals filing separately face much tighter limits, and in many cases no allowance at all.
Real estate professional status
Taxpayers who qualify as real estate professionals can escape the automatic passive treatment of rentals. To qualify for a given tax year, you generally must meet both of these tests:
- More than half of the personal services you perform in all trades or businesses during the year are performed in real property trades or businesses in which you materially participate.
- You perform more than 750 hours of services during the year in those real property trades or businesses.
Real property trades or businesses include development, construction, acquisition, rental, management, leasing, and brokerage. Hours worked as an employee generally do not count unless you own more than 5 percent of the employer.
For married couples filing jointly, one spouse must meet both tests alone. Spouses' hours cannot be combined to qualify, although they can be combined for material participation.
Someone with a full-time job outside real estate will rarely meet the more-than-half test. Real estate professional status is most realistic for full-time landlords, contractors, agents, and property managers, or for a household where one spouse works primarily in real estate.
Material participation in the rentals themselves
Qualifying as a real estate professional is only the first step. You must also materially participate in the rental activity. The IRS provides several tests for material participation, the most common being more than 500 hours in the activity during the year.
By default, each rental property is a separate activity, so material participation would be tested property by property. Most real estate professionals with multiple properties make an election to treat all their rental real estate as a single activity, which makes the hours test far easier to meet. That election is generally binding for future years, so it deserves careful thought.
Documentation is everything
Real estate professional status is a frequent subject of IRS examination, and the burden is on the taxpayer to prove hours. Reconstructions done after the fact are often given little weight.
Keep a contemporaneous log showing:
- The date and number of hours
- The property involved
- What you did, such as tenant showings, repairs, bookkeeping, or meetings with contractors
Calendars, emails, invoices, and mileage logs can support the log. Investor-type activities, such as reviewing financial statements without being involved in operations, generally carry less weight.
What happens to suspended losses
Suspended passive losses are not lost. They carry forward indefinitely and can be used against future passive income. When you dispose of your entire interest in a rental activity in a fully taxable transaction, such as a sale to an unrelated buyer, the remaining suspended losses from that activity generally become deductible that year.
That is one reason we track suspended losses carefully for each property. Our article on depreciation and what happens when you sell covers the sale side, and our real estate and rental accounting services include maintaining these carryforwards for Central New York landlords from year to year.
Frequently asked questions
Can I deduct rental property losses against my W-2 income?
Possibly. If you actively participate and your modified adjusted gross income is under $100,000, you may deduct up to $25,000 of rental losses. The allowance shrinks between $100,000 and $150,000. Above that, losses are generally suspended unless you qualify as a real estate professional.
Does a full-time job disqualify me from real estate professional status?
Usually, yes. You must spend more than half of all your working hours in real property trades or businesses, so a full-time job outside real estate generally makes the test impossible to meet. A spouse who works primarily in real estate may qualify, though.
What counts toward the 750 hours?
Hours spent in real property trades or businesses in which you materially participate, such as managing, leasing, repairing, and operating rentals, or working in construction or brokerage as an owner. Employee hours generally count only if you own more than 5 percent of the employer.
Do suspended passive losses ever expire?
No. They carry forward until you have passive income to absorb them or until you dispose of your entire interest in the activity in a fully taxable transaction.
This article is general information for 2026, not tax or legal advice for your situation. Tax rules and figures change; confirm current amounts with the IRS, New York State, or your accountant before acting.
Related service: Real Estate & Rental Property Accounting