If you own rental property, there’s a little-known IRS rule that can make a big difference in your taxes. It allows certain investors to offset up to $25,000 of rental real estate losses against nonpassive income, like wages or business income. For many people, this is the difference between paying thousands in taxes and keeping more cash in the family.
Who qualifies
To take advantage of this deduction, you need to meet a few criteria. You must own at least 10 percent of the rental property. You must actively participate in key management decisions. And your modified adjusted gross income, or MAGI, has to be $100,000 or less to claim the full $25,000. The deduction gradually phases out as your income rises, disappearing entirely at $150,000.
What active participation really means
Active participation is less strict than material participation. It doesn’t require 500 hours of work or constant involvement. You qualify if you make meaningful decisions about the property, like approving new tenants, setting rental terms, arranging repairs, or selecting contractors. Typically, more than 100 hours a year, with involvement at least as much as any other individual, is enough.
You don’t need detailed time sheets. Appointment books, calendars, or even a written summary of the tasks you handled can serve as evidence. Activities done just to avoid losing the deduction don’t count. The IRS wants to see real engagement.
How the deduction works
If you meet the criteria, you can deduct up to $25,000 of rental losses against your nonpassive income. Losses beyond that can be carried forward to future years or deducted in full when you sell the property. This can dramatically reduce your taxable income, especially if you are actively involved in managing your rentals.
Estimating your MAGI for the phaseout
Your MAGI determines how much of the $25,000 allowance you can use. Start with your AGI from your tax return and add back any excluded foreign earned income, foreign housing costs, deductions for previously excluded passive income or rental losses, and certain tax-exempt interest income. The $25,000 deduction phases out starting at $100,000 MAGI and disappears completely at $150,000.
Why it matters
This is more than a tax strategy. It’s a way to reward investors who are actively managing their properties. If you’re approving tenants, agreeing to repairs, and making strategic decisions about your rentals, this rule can turn paper losses into real tax savings. For active rental property investors within the income limits, it is one of the few opportunities to offset nonpassive income with rental losses.
