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Real Estate Tax Law: PAL is Your Friend

The recent crisis in the US housing market means that more and more distressed and foreclosed properties go on the market and demand for rental housing continues to rise. These factors combine to create a virtually unprecedented window of opportunity for retirees and anyone seeking financial freedom to start a new career in real estate investing. And, as Jason Hartman recommends, it’s smart to launch that career by purchasing multiple properties. Diversifying your property holdings has many benefits, one of which is to help you sidestep a little known real estate tax rule called passive activity loss, or PAL.

As we’ve discussed in previous posts, the generous tax breaks afforded to landlords included deductions for items such as mortgage interest, repair and maintenance, travel and home office expenditures. In general, the more active a role you take in the management of your properties, the more deductions you can claim for things you do related to maintaining and upgrading it.

But for some new investments, loss precedes profit. Being able to deduct those losses can be essential to surviving. PAL rules affect how much, and under what circumstances, rental property owners can claim losses on taxes. Two key factors which affect your deductions for passive activity losses are whether you have passive income from other rental properties, and how actively you participate in activities related to the rental properties.

In general, passive activity loss deductions work with passive activity gains. The basic principle governing PAL deductions is simply this: you can deduct passive losses from one property only to the extent that you can demonstrate passive income from other rental property sources, such as a positive rental income or gains from selling properties you own.

But even if neither of those situations applies, you can still claim PAL deductions under some circumstances. If your adjusted gross income before your real estate losses is under $100,000 and you actively participate in rental-related activity, you can typically deduct up to $25,000 in passive income losses. Active participation includes such things as owning a 10% or greater interest in the property and making management decisions like signing leases, arranging repairs and screening tenants.

Jason Hartman’s real estate investing strategies emphasize that it’s smarter to be a hands-on owner of your rental properties rather than outsourcing management to a property manager or company. The PAL rules demonstrate another reason why this is true: if you use a management company rather than attending to those jobs yourself, you won’t be eligible for the $25,000 PAL deduction.

Also, the law supports people who do take an active role in managing their properties. One factor in becoming eligible for PAL exemptions is the amount of time you spend managing your properties. Some exemptions require that you spend more than 750 hours annually in activities related to managing your properties – and these hours’ must total more than 50% of your entire working life.

Launching a career as a real estate entrepreneur is not without its challenges. But by purchasing multiple properties and managing them directly, you can take advantage of the numerous aspects of US tax law designed to support property owners just like you.

The Heroic Investing Team


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