If any of your income is derived from rental real estate, this information is significant.
Income from rental real estate is considered “passive” income. There is nothing wrong with having passive income. Just remember that it is treated differently under US tax law than the income you earn from your employment.
Employment income, whether earned from another or from self-employment, is active income.
The advantages of active income are:
1. More liquid than passive income.
2. Losses are usually fully deductible in the year incurred.
The advantages of passive income are:
1. Taxed at a lower rate than the income you earn (which I think is strange.)
2. Not deductible against active income beyond $3,000 per year, presently.
3. capable of carryforward or carryback to apply to active profits.
The challenge for active managers of family rental real estate is to demonstrate the level of active engagement in management of the properties.
I contend that residential real estate properties require higher levels of attention than do commercial real estate rentals due to:
1. the protections afforded to families in their homes, whether rented or owned.
2. required response to emergencies 24 hours a day, seven days a week.
3. residential landlords must provide longer periods of notice for eviction actions (unlawful detainer.) While the residential landlord is required to provide 30 days notice, a commercial landlord may issue a “3-day pay or quit” notice.
Highlights important to my clients:
Before we get into the really hard part, there is an easy thing that people often miss. Getting the real estate pro status just relieves you of the “per se” passive rule. You still have to materially participate in each of the activities. If you have several properties this can be virturally impossible. You are allowed to elect to aggregate all your properties together, but many people miss that election, as did Ms. Hudzik, although she did not get far enough for that to matter.
You also have to spend more time on the real estate activities than you do on anything else. This generally proves to be an insurmountable obstacle for amateur landlords with day jobs, particularly since there is a much harder unstated requirement.
(Hudzik says if you have W-2 income at a level that indicates full-time employment, thou shalt not be a Real Estate Professional.)
So, elect to aggregate your properties together to take that election; do not have a day job; and be married or RDP.
Let’s talk about your situation.