Tax Partner
When most people think about owning rental property, they focus on the extra monthly cash flow. But there’s another side to rental real estate that’s just as valuable: the potential tax savings that come from rental losses.
With the right strategy, certain types of rental losses — often created by depreciation and other deductions — can help reduce your ordinary taxable income, such as W-2 wages or income from a business. However, not all rental losses automatically offset other types of income. The rules depend on how the rental activity is classified for tax purposes.
Here’s an overview of the main situations where rental losses may help offset your job or business earnings:
- Short-Term Rentals (Airbnb, VRBO)
Short-term rentals can sometimes be classified as non-passive if you materially participate. For example, if you rent out a property on a short-term basis (e.g., via Airbnb or VRBO), your rental activity could be treated more like an active business.
In general, if the average rental period is 7 days or less, it may not be considered a typical rental activity — allowing your losses to potentially offset other ordinary income if you meet the material participation tests.
- Real Estate Professionals
If you qualify as a real estate professional under the tax rules, your rental activities are not considered passive — as long as you materially participate. This means your rental losses can fully offset your W-2 or business income.
To qualify, you generally must:
- Spend more than 750 hours a year in real estate trades or businesses, and
- More than half of your total working hours must be in real estate.
Qualifying as a real estate professional involves specific IRS rules, so be sure to consult a tax advisor to confirm your status.
- Passive Rental Income and Losses
Most residential rental properties are considered passive activities by the IRS. This means any rental losses are usually classified as passive losses, which generally cannot offset your W-2 wages or active business income.
However, there is an important exception: if you actively participate in your rental and your income is below certain limits, you may be able to deduct up to $25,000 of rental real estate losses against your ordinary income. This special allowance phases out between $100,000 and $150,000 of modified adjusted gross income.
Without this exception or other special status, rental losses typically only offset other passive income.
Illustration: Potential Tax Savings From Using Rental Losses to Offset Ordinary Income
| Scenario | You Can Offset W-2 or Business Income
with Rental Losses |
You Cannot Offset W-2 or Business Income
with Rental Losses |
| W-2 or Business
Income |
$1,000,000 | $1,000,000 |
| Rental Loss (Depreciation
+ Expenses) |
($100,000) | ($100,000) (passive – cannot offset) |
| Adjusted Taxable
Income |
$900,000 | $1,000,000 |
| Assumed Marginal
Tax Rate |
37% | 37% |
| Estimated Tax
Liability |
$333,000 | $370,000 |
| Tax Savings by Using
Rental Loss |
$37,000 | $0 |
Explanation:
If your rental losses are allowed to offset your W-2 wages or business income, your taxable income drops from $1,000,000 to $900,000 — lowering your tax bill by $37,000 in this example.
If rental losses are considered passive and can’t offset ordinary income, your taxable income remains $1,000,000, and you miss out on the tax savings.
Key Takeaway
Rental real estate can be a powerful tax strategy — but whether you can use rental losses to offset your W-2 wages or business income depends on how your rental activity is classified under the tax code and whether you actively participate.
A well-planned rental strategy, good recordkeeping, and proactive tax advice can make a big difference. Please contact WFY here for any further questions. You can sign-up for our newsletter here to receive more updates.
Wright Ford Young & Co. is headquartered in Irvine, CA and is one of the largest local CPA firms in Orange County. WFY is a full service corporate accounting firm offering audit, tax, estate and trust, and business consulting services to closely held company and family business owners. More information about our Firm can be found at www.cpa-wfy.com.