Real Estate

Real Estate Professionals: How to Qualify for Special Tax Deductions on Rental Losses

Ryan Malone | 04/05/2025

Unlocking Tax Benefits: Are You a Qualified Real Estate Professional Under IRS Rules?

When it comes to rental property losses, most taxpayers hit a wall: the IRS classifies these as passive activity losses (PALs), which can typically only be deducted against passive income. So, unless you have other passive gains—like from additional rental properties—your losses may be stuck in limbo, carried forward to future years.

But here’s the good news: there’s a valuable tax exception for those who meet the IRS criteria as real estate professionals. Let’s explore what it means to qualify and how this designation could help you deduct rental losses now instead of later.

Understanding Passive Activity Losses (PALs)

Under standard federal tax rules, rental real estate losses are considered passive. If your other income (like from a W-2 job or business profits) isn’t passive, you can’t use these rental losses to reduce your tax liability. Instead, they’re carried forward into future years until you either:

Generate enough passive income, or
Sell the property that caused the loss.

The Real Estate Professional Exception

The IRS makes an exception for taxpayers who are materially involved in real estate activities. If you qualify as a real estate professional, your rental losses may be reclassified as non-passive, meaning you can deduct them against your regular income.

To qualify, you must:

Spend more than 750 hours per year in real estate activities in which you materially participate, and
Work more hours in real estate than in all your other trades or businesses combined.

Once you meet this threshold, you must also prove material participation in each rental activity to make those losses non-passive. The three easiest ways to do this include:

Spending over 500 hours annually on the activity,
Spending over 100 hours, and more time than any other individual, or
Performing substantially all the work related to the property.

What If You Don’t Qualify as a Real Estate Pro?

Not everyone can meet the 750-hour requirement, especially if you have a full-time job elsewhere. But there are still some alternative exceptions that could let you deduct rental losses now:

1. The $25,000 Small Landlord Exception

If you:

Own at least 10% of the rental property, and
Actively participate in its management (approving tenants, leases, or repairs),
You may be able to deduct up to $25,000 in rental losses annually. This deduction begins to phase out when your adjusted gross income (AGI) exceeds $100,000 and disappears entirely at $150,000.

Note: Properties owned through limited partnerships don’t qualify.

2. 7-Day Average Rental Rule

If your rental property’s average lease duration is seven days or less, it’s treated as a business rather than a passive activity. If you meet one of the material participation tests, losses from this property are non-passive and deductible.

3. 30-Day Rule with Services Provided

When your property is rented out for an average of 30 days or less and you provide substantial personal services (like cleaning, concierge, or meal service), the IRS may also treat it as a business activity. Again, if you materially participate, you can deduct those losses immediately.

Maximize Every Available Tax Break

Navigating the world of rental property tax rules can be complicated—but it’s also filled with opportunity. Whether you qualify as a real estate professional or fall under one of the exceptions, it’s worth evaluating your eligibility every year.

Our team can guide you through the requirements and help you maximize every available deduction. Don’t let your rental losses go to waste—let us help you make the most of your investments at tax time. Contact us today for a personalized consultation and let our experts help you make the most of your rental property deductions.

The Benefits of Separating Your Business from Its Real Estate

Ken Botwinick, CPA | 10/15/2024

If your business requires real estate to operate or holds property under its business name, it might be time to reconsider this approach. Separating business operations from real estate ownership offers several long-term benefits, including tax savings, liability protection, and enhanced estate planning options. This strategy could be a smart move for business owners looking to maximize their financial advantages.

Tax Benefits of Separating Real Estate from Your Business

For businesses structured as C corporations, real estate is often treated like any other business asset such as equipment or inventory. Expenses related to owning these assets are typically deductible, appearing as ordinary business expenses on income statements. However, issues arise when it comes to selling the real estate. In a C corporation, the profits from the sale of property are subject to double taxation—once at the corporate level and again when distributions are made to individual shareholders.

By transferring ownership of the real estate to a pass-through entity such as an LLC or an LLP, you can avoid double taxation. With this setup, profits from a real estate sale are taxed only at the individual level, helping you retain more of your earnings and reducing your overall tax burden.

Asset Protection and Liability Shield

Separating real estate ownership from the business can also safeguard your assets. If your business faces a lawsuit or creditors seek compensation, they could potentially target all assets, including real estate owned by the business. However, if the real estate is held under a separate legal entity, it becomes much harder for plaintiffs or creditors to seize that property.

This separation can also protect you during bankruptcy proceedings. Generally, creditors cannot recover real estate held by a separate entity unless the property was used as collateral for business loans. This makes separating real estate an excellent way to shield valuable assets from legal risks.

Estate Planning Advantages

Keeping real estate separate from the business can provide more flexibility in estate planning. For instance, if you own a family business and not all of your heirs are interested in managing the company, you have the option to pass the business to one heir and the real estate to another. This separation of assets allows for smoother inheritance and distribution of wealth among family members.

How to Separate Real Estate from Your Business

If you’re ready to explore this strategy, you can transfer ownership of the business property to a different entity and lease it back to the company. One option is for the business owner to purchase the real estate from the business, holding the title under their own name. However, this approach could expose the owner to liabilities, putting their personal assets at risk.

A better alternative is to transfer the property to a separate legal entity, typically an LLC or LLP, specifically formed to hold real estate. LLCs are easier to set up, requiring just one member, while LLPs require at least two partners and are not permitted in every state. An LLC, with its pass-through taxation structure, allows any real estate expenses to be deducted on your individual tax return, offsetting rental income from leasing the property to the business.

Risks and Considerations

While separating your business from its real estate offers many advantages, it may not be the best strategy for every situation. It’s important to assess the potential costs, capital gains taxes, and the risks of transferring liabilities. In some cases, the liabilities associated with the property could still pose risks to the business, especially if an incident like a client injury occurs on-site, leading to a lawsuit.

Take the Next Step

Deciding whether to separate your business from its real estate can be complex. The best approach depends on your specific business needs, tax considerations, and long-term financial goals. Consulting with tax and legal professionals can help you determine the most effective strategy for minimizing transfer costs, reducing taxes, and protecting your assets. By separating your business from its real estate, you can unlock significant tax benefits, protect your assets, and enhance your estate planning. For expert guidance tailored to your unique situation, contact us today to learn how we can help you maximize these advantages and secure your financial future.

Q&As:

How do taxes affect the sale of real estate owned by a business?

If a C corporation owns real estate, the profits from its sale are taxed twice: first at the corporate level and then at the individual level when profits are distributed. This double taxation can be avoided by transferring the real estate to a pass-through entity, where the sale is taxed only at the individual level.

How can separating real estate from a business safeguard assets?

By keeping real estate ownership separate from the business, you protect the property from creditors and lawsuits targeting the business. In the event of a lawsuit or bankruptcy, property owned by a separate entity is generally shielded unless it was used as collateral for business debts.

What are the estate planning benefits of separating real estate from a business?

Separating real estate from a business provides flexibility in estate planning, especially in family-owned businesses. If not all heirs are interested in running the business, you can distribute the real estate to one family member and the business to another, offering more balanced asset distribution.

What are the considerations when handling a real estate transfer from a business?

When transferring real estate ownership, an LLC or LLP is often used to hold the property. An LLC is typically easier to establish and offers liability protection. The business owner could also personally purchase the real estate, but this carries the risk of assuming property-related liabilities, which could impact the business if lawsuits arise.

Decoding Real Estate Capital Gains Taxes

Ken Botwinick, CPA | 08/12/2024

If you own real estate that has appreciated over time and decide to sell it after holding it for more than a year, you might expect to pay the standard federal income tax rates of 15% or 20% on your long-term capital gains. This applies whether you own the property directly or through a pass-through entity like an LLC, partnership, or S corporation.

However, taxes on real estate gains can sometimes be more complex, particularly when depreciation is involved. Below is a breakdown of key federal income tax considerations that may impact the taxes on your real estate gains.

Taxes on Vacant Land

For sales of vacant land, the maximum federal long-term capital gain tax rate is currently 20%. This rate applies only to those with high incomes. For example, in 2024, the 20% rate kicks in for:

Single filers with taxable income over $518,900,
Married couples filing jointly with taxable income over $583,750, and
Heads of household with taxable income over $551,350.

If your income is below these thresholds, your land sale gain will generally be taxed at a 15% rate. However, you may also owe the 3.8% net investment income tax (NIIT) on some or all of the gain, depending on your overall income.

Gains from Depreciation

When you sell real estate, a portion of your gain may be due to depreciation you previously claimed. This is known as “unrecaptured Section 1250 gain,” which is typically taxed at a flat 25% federal rate. However, if your taxable income would place you in a lower tax bracket, the gain may be taxed at that lower rate instead. Additionally, the 3.8% NIIT may also apply to this gain.

Gains from Depreciable Qualified Improvement Property

Qualified improvement property (QIP) refers to certain improvements made to the interior of nonresidential buildings, excluding expansions, elevators, escalators, or structural framework. You may have claimed first-year Section 179 deductions or bonus depreciation on QIP. If you sell QIP:

Any gain up to the amount of Section 179 deductions claimed will be taxed as high-taxed Section 1245 ordinary income. This means it will be taxed at your regular income tax rate rather than the lower long-term capital gains rate.
If you claimed bonus depreciation, any gain up to the amount of the bonus depreciation deduction over what would have been claimed under straight-line depreciation will also be taxed as high-taxed ordinary income.

In either scenario, the 3.8% NIIT may apply to some or all of the gain.

Strategic Tax Planning Tip

If you choose to use straight-line depreciation for your real property, including QIP, instead of claiming Section 179 or bonus depreciation, you can avoid Section 1245 and Section 1250 ordinary income recapture. In this case, your gain will be treated as unrecaptured Section 1250 gain, which is taxed at a maximum federal rate of 25%. However, the 3.8% NIIT may still apply.

As you can see, the tax implications of selling real estate can be more complicated than they might appear at first glance. Different tax rates may apply depending on the nature of the gain, and you may also face additional taxes like the 3.8% NIIT or state income taxes. To navigate these complexities and optimize your tax situation, reach out to us. We’re here to handle the details when it’s time to prepare your tax return and to answer any questions you may have.

Separating Your New Jersey Business From Its Real Estate

Ken Botwinick, CPA | 09/15/2022

Does your business need real estate to conduct operations? Or does it otherwise hold property and put the title in the name of the business? You may want to rethink this approach. Any short-term benefits may be outweighed by the tax, liability, and estate planning advantages of separating real estate ownership from the business.

Tax implications

Businesses that are formed as C corporations treat real estate assets as they do equipment, inventory, and other business assets. Any expenses related to owning the assets appear as ordinary expenses on their income statements and are generally tax deductible in the year they’re incurred.

However, when the business sells the real estate, the profits are taxed twice — at the corporate level and at the owner’s individual level when a distribution is made. Double taxation is avoidable, though. If the ownership of the real estate were transferred to a pass-through entity instead, the profit upon sale would be taxed only at the individual level.

Protecting assets

Separating your business ownership from its real estate also provides an effective way to protect it from creditors and other claimants. For example, if your business is sued and found liable, a plaintiff may go after all of its assets, including real estate held in its name. But plaintiffs can’t touch property owned by another entity.

The strategy also can pay off if your business is forced to file for bankruptcy. Creditors generally can’t recover real estate owned separately unless it’s been pledged as collateral for credit taken out by the business.

Estate planning options

Separating real estate from a business may give you some estate planning options, too. For example, if the company is a family business but some members of the next generation aren’t interested in actively participating, separating property gives you an extra asset to distribute. You could bequest the business to one heir and the real estate to another family member who doesn’t work in the business.

Handling the transaction

The business simply transfers ownership of the real estate and the transferee leases it back to the company. Who should own the real estate? One option: The business owner could purchase the real estate from the business and hold title in his or her name. One concern is that it’s not only the property that’ll transfer to the owner, but also any liabilities related to it.

Moreover, any liability related to the property itself could inadvertently put the business at risk. If, for example, a client suffers an injury on the property and a lawsuit ensues, the property owner’s other assets (including the interest in the business) could be in jeopardy.

An alternative is to transfer the property to a separate legal entity formed to hold the title, typically a limited liability company (LLC) or limited liability partnership (LLP). With a pass-through structure, any expenses related to the real estate will flow through to your individual tax return and offset the rental income.

An LLC is more commonly used to transfer real estate. It’s simple to set up and requires only one member. LLPs require at least two partners and aren’t permitted in every state. Some states restrict them to certain types of businesses and impose other restrictions.

Proceed cautiously

Separating the ownership of a business’s real estate isn’t always advisable. If it’s worthwhile, the right approach will depend on your individual circumstances. Contact us to help determine the best approach to minimize your transfer costs and capital gains taxes while maximizing other potential benefits.