Landlords and (“passive”) losses: What if expenses exceed income?

It isn’t easy being a landlord. Trying to keep customer-tenants satisfied enough to renew their leases is often a frustrating and not necessarily lucrative endeavor.

The tax code often isn’t much help either, with arcane rules limiting the ability of real estate owners to deduct losses. These rules concern what the code calls “passive activity losses,” also known as PALs.

Given these rules, what happens if your expenses for rental activities exceed your income?

The general rule is that rental real estate is considered “passive activity” under the federal tax code. That means you generally don’t get to deduct losses from rental property.

There are, however, certain exceptions to this rule. One is for “active investors” with modified adjusted gross income below a certain threshold ($100,000) who own at least a 10 percent stake in the property and do not delegate its management to a third-party company.

The other exception is for real estate professionals. Under the rules, professionals are defined as devoting 750 hours or more per year to real estate activities.

In a recent case in New York, a taxpayer who had a fulltime job in another industry contended that he was also a real estate professional. He argued that he used spare time during his regular job to also work on his real-estate business.

The Division of Tax Appeals for the State of New York did not accept his argument. As a result, the taxpayer was unable to deduct nearly $74,000 in losses.

This case is just one reminder of how difficult being a part-time landlord can be. Headaches can come not only from issues with tenants, but from the tax code itself.