Rental Real Estate Tax Implications

By Tom Andrews, CPA

As the real estate market continues to rebound and interest rates remain historically low yachting professionals are continuing to invest in real estate.  Since traveling is a cornerstone of a yacht crewmembers  career,  becoming  a land lord is a common progression for many yachties.  Aside from the daily obstacles of becoming a landlord owning rental real estate adds an entirely new dynamic to a yacht crewmembers tax profile.

Rental real estate offers tax advantages and opportunity for tax planning. Taxpayers can depreciate property, deduct interest on borrowed capital, exchange rather than sell properties to defer tax on gains, use installment sales to defer tax on sales, and profit from preferential rates on long-term capital gains. Most importantly, you can generate “positive cash flow,” or monthly income, with depreciation deductions that effectively turn the actual income into tax losses.

However, deductions are not unlimited. For example, real estate income and loss is generally considered passive income and loss for tax purposes. Taxpayers generally cannot use passive activity losses (PALs) to offset ordinary income from employment, self-employment, interest and dividends, or pensions and annuities. The rental real estate loss allowance and real estate professional status are two important exceptions to this rule. In addition, the tax consequences of renting out a vacation home depend upon the amount of time the home is rented and the amount of time you use the home for personal purposes.

As one exception to the PAL rules, taxpayers with adjusted gross incomes of $150,000 or less can claim a rental real estate loss allowance of up to $25,000 for property they actively manage. Active management does not require regular, continuous, or substantial involvement. However, it does require that the taxpayer own at least 10% of the property. Also, to qualify for the exception, married taxpayers must file jointly.  It should be noted that if your rental activity losses are limited due to your income, those losses may become “suspended” to a year in which your income falls below the income threshold or you sell the rental property.

The second exception allows real estate professionals not to treat their rental activity as a passive activity. Therefore, their losses are not limited to passive income. This exception requires material participation by the taxpayer which is demonstrated by meeting one of seven tests. These tests are complex and include the number of hours of participation and the facts and circumstances of the participation in the activity.

For a complete analysis regarding the tax consequences of residential rental property review Publication 527 at the IRS website (

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