There are many different types of real estate professionals in the market. Some do it for a living, while others manage one or two properties for supplemental income. The business tax deduction rules vary greatly depending on how you are classified as a real estate investor as detailed in IRS Publication 925.
To qualify as a real estate professional for tax purposes, you need to meet the following requirements:
- More than 50% of your professional services are provided in the real estate field
- You spend more than 750 hours each year in managing a real estate business
- You are not an employee of the business (unless you own at least 5% of the business)
- You must also materially participate in the rental activity
If you do not meet the qualified real estate professional criteria, then by default the losses are treated as passive (IRC Section 469). This means that you can offset other income, such as wages, up to $25,000 per year via Form 8582. Any losses over $25,000 that are not allowed in the current year are carried forward and can only be used when you have net income from the passive rental or when you entirely dispose of the rental property.
If you do meet the real estate professional criteria, you will have non-passive losses which can be carried forward as NOLs and offset against other non-passive income. Generally, if you have an NOL you must carry back the entire amount of the NOL to the 2 tax years before the NOL year (the carryback period), and then carry forward any remaining NOL for up to 20 years after the NOL year (the carryforward period). You can, however, choose not to carry back an NOL and only carry it forward. To choose to elect to only carryforward the NOL, attach a statement to your original return filed by the due date (including extensions) for the NOL year. This statement must show that you are choosing to waive the carryback period under IRC section 172(b)(3) and IRS Publication 536.
As you can see, the rules for deducting real estate losses can vary greatly depending on the real estate investor.