Rental real estate activities are generally considered to be passive activities for tax purposes, and you can deduct real estate rental losses only to the extent you have other passive income. But if you materially or actively participated in the rental activity, you may be able to deduct a loss. And, in the case of a dwelling unit used as a home, the passive activity rules do not apply.
At-Risk Rules
If the passive activity rules apply, any losses are first subject to the at-risk rules. These rules are intended to limit losses from activities that are considered to be tax shelters. The rules basically limit the loss to the amount that is at risk in the activity; that is, the amount of cash and the adjusted basis of property contributed to the activity, and certain amounts borrowed for the activity. If the at-risk rules apply, you will generally have to complete Form 6198 to figure your allowable loss if you have a loss from an activity that you carry on as a trade or business or for the production of income, and you have amounts in the activity for which you are not at risk.
Passive Activity Rules
Losses that are deductible after considering the at-risk rules are then subject to the passive activity loss rules. Under these rules, as indicated above, you can generally deduct losses only to the extent you have offsetting income from other passive activities.
Rental activities in which you actively participated as a real estate professional are not considered to be passive activities and are not subject to the passive activity limits. You are considered a real estate professional if:
More than half of the personal services you performed were in real property trades or businesses in which you materially participated, and
You performed more than 750 hours of services in real property trades or businesses in which you materially participated.
Material and Active Participation
If you are not a real estate professional, you will need to determine if you materially and actively participated in the rental activity, to see whether the passive activity limits apply. Material participation means you were involved in rental operations on a regular, continuous and substantial basis. Active participation means you (and your spouse) owned at least a 10% interest in the rental property and you made management decisions in a significant and bona fide sense.