Maximizing the benefits of rental properties

Active advice on the tax implications of passive income.

Troy L. Whitaker, Los Angeles
I earn over $100,000 a year. Does that mean I can’t deduct my rental properties’ mortgage interest? As I understand it, I can only deduct it from the income I make off my renter. Is that correct?

By Shara Rutberg, Fortune Small Business contributor
Dear Troy: We’d need more information about your specific situation to provide a definitive answer; however, here are a few general points to consider.

The rental income from your properties is considered a “passive” activity.

“You can only take deductions related to a passive activity to the extent of income from that activity, but there are a couple of exceptions,” says Tom Ochsenschlager, vice president, taxation of the American Institute of Certified Public Accountants.

One exception comes in when you “actively participate” in the rental activity. If you do, you can take a deduction of as much as $25,000 in excess of the rental income, explains Ochsenschlager.

However: "The $25,000 is phased out by 50 cents for every dollar your adjusted gross income exceeds $100,000," he says. "So, it’s completely phased out when your adjusted gross income exceeds $150,000. Therefore, depending on you income, you may get some benefit.”

What does “actively participate” mean?

“It’s rather vague,” says Ochsenschlager. “You don’t have to snake out drains, but you should do such things as approve tenants, rental terms, repairs, etc. ‘Active management’ might be a better phrase.”

Assuming you are renting to make a profit and not living in any of these properties, your deductible rental expenses can be more than your gross rental income, says Vicki H. Meyer, counsel to Thomas Howell Ferguson PA in Tallahassee. Your rental losses, however, may be limited by the "at-risk" rules in addition to the passive-activity loss rules. The at-risk rules limit your losses from most activities to your amount at risk in the activity.

“You carry any excess loss forward to the following year or years until used, or the losses may be fully deducted in the year you dispose of your entire interest in the activity in a fully taxable transaction. Therefore, losses limited by the passive loss rules are delayed, not denied,” Meyer says. Getting your deduction many years later, when you dispose of the property, may lessen the value of the deduction, she adds.

Disclaimer: This column provides general information only and is not intended to replace the services or legal advice of an attorney or CPA. Always consult a lawyer or accountant regarding specific legal or financial issues.

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Related links:

Living in a property your business owns

Tax breaks for real-estate losses

A guide to evicting a tenant