The federal lax code limits the deducibility of any passive losses. In general, passive losses cannot be deducted except to the extent that they are offset by passive gains in the same year. Any excess passive losses have to be carried forward and applied against passive gains in the following year.

Example: An investor has passive losses of $4000 every year in an oil and gas exploration investment. Those losses cannot be deducted, unless the investor can offset up to $4000 in passive income during the same year. Any unused losses have to be carried over to future tax years. Formerly, passive losses were completely deductible. It was possible to save more in taxes than the amount invested, so investors had every incentive to invest in such programs. The passive loss limitation changed all of that. The new rules did away with abusive shelters. Fortunately, one exception to the passive loss limitation rules was made, and that was for real estate investments. Congress recognized that well-planned real estate investments were economically viable and not abusive as were other types of passive activities. If you have passive losses from real estate investments, you can deduct those losses if you meet the following five requirements:

1. Your net passive losses cannot exceed $25,000 in any one year. You can offset real estate losses against other income, as long as your loss does not exceed $25,000. This allowance extends only to real estate passive losses. Any excess losses are carried forward, subject to the same restrictions in the following year.

2. You have to actively be involved in managing your real estate investments. You must be an active participant to qualify for passive loss deductions. That means you have to make decisions about which tenants to approve, hire others to make repairs and maintain the property, and manage the financial transactions. If you hire a property management company, you will still be an active participant as long as you continue to confer and review regularly with the manager.

3. You own at least 10 percent of the property. It is possible to own properly jointly with other people as a joint venture, small business corporation, or general partnership. This is not a problem as far as passive loss deductions are concerned, as long as you meet the other requirements and own 10 percent or more of the property.

4. Vow are not a passive participant by definition. You must own property directly, meaning you lose the right to a deduction of passive losses if you are a limited partner. A limited partner has no voice in management, by contract. a general partner has all the rights and responsibilities for management of properties.

5. Your grass income (adjusted), not including property losses, is (less than $100,000. Another limitation on deductibility of passive losses is based on your level of adjusted gross income based on the federal income tax return. It the adjusted gross income {not including passive losses from real estate) is less than $100,000, then the deduction is allowed in full. However, for ever)' dollar of adjusted gross income above $100,000, the deduction is reduced by 50 cents. So once adjusted gross income reaches $150,000, no deducibility is allowed for passive losses.

 

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