The tax laws authorize various incentives for investors who move money into real estate ventures and other kinds of tax shelters, such as limited partnerships. The key attraction for investors is that these real estate deals are designed to generate large paper losses, at least in the short term.
But the tax rules become harsh and complicated for real estate investors who incur losses deemed to be “passive.” Generally, investors can’t make use of these losses to offset income they derive from salaries, self-employment income, interest, dividends, sales of investment properties, pensions and withdrawals from IRAs or other retirement arrangements.
Disallowed losses are suspended and carried forward indefinitely to later taxable years. The passive loss rules prohibit investors from deducting their losses until they realize passive income or sell their passive investments.
Which real estate investors are subject to the convoluted restrictions on passive losses? Only passive investors — meaning individuals who don’t "materially participate" in their venture’s operations (not investors who do materially participate), and meaning individuals actively involved in business operations.
How actively involved must investors be to free themselves from the passive-loss limitations? The involvement must be year-round, on a "regular, continuous, and substantial basis."
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About Julian Block
Attorney and author Julian Block is frequently quoted in the New York Times, Wall Street Journal, and the Washington Post. He has been cited as “a leading tax professional” (New York Times), an “accomplished writer on taxes” (Wall Street Journal), and “an authority on tax planning” (Financial Planning magazine). More information about his books can be found at julianblocktaxexpert.com.