Can RE Professional Deduct Prior Passive Losses?

January 17th, 2025 at 6:20 AM

When deducting your rental property tax losses against your other income is tricky, as you likely know. You have to get the tax law to treat you—say, a computer engineer—as a tax-code–defined real estate professional.

Let’s say you get there. Does that status allow immediate use of suspended passive losses? Unfortunately, the answer is no. Here’s why.

Understanding Passive Loss Rules

The tax code limits passive loss deductions to passive income, with any excess carried forward to future years. You release the carried-forward losses when you

• have offsetting passive income from the same or other passive activities, or
• completely dispose of the activity generating the loss.

Real Estate Professional Status

Qualifying as a real estate professional under IRS rules requires meeting two tests annually:

• Spend more than 50 percent of your work time in real property trades or businesses.
• Perform at least 750 hours of your work in real property trades or businesses.

Material Participation

Additionally, you must materially participate in the rental activity to create non-passive losses.

The Two-Part Solution

Meeting (1) the real estate professional test and (2) the material participation standard allows current-year rental losses to offset non-passive income, such as wages or business income.

Impact on Prior Passive Losses

Qualifying as a real estate professional is not retroactive. Suspended passive losses from prior years remain subject to the original rules. You can use the prior suspended losses in the following ways:

• To offset passive income from the same or other passive activities
• When you completely dispose of the activity that created the suspended passive losses

Key Takeaways

Real estate professional status offers valuable tax benefits for your rental properties but does not free up prior passive losses. Annual testing is required to maintain this status.

Mark DS. Fineberg, CPA