Q My wife and I are in a high tax bracket and are considering buying rental properties to save taxes. Our understanding is that we can depreciate the properties and benefit from the tax losses created from the depreciation. Is this true?

A Generally, rental real estate is considered a passive activity. Passive losses are only deductible to the extent you have passive income. In other words, you can offset your passive income with passive losses. Unused passive losses are carried forward until you have passive income to offset, or you dispose of the passive activity freeing up that activity’s passive loss for a deduction.

However, there is a limited exception to the passive activity loss rules for rental real estate in which the taxpayer actively participates. An individual may meet the “active participation” requirement by participating in the management decisions (i.e. approving tenants, collecting rents, providing services, etc.) in a significant and bona fide sense. This exception allows a deductible loss of up to $25,000. To be eligible for this exception, you must own at least a 10% interest of all interests in the activity throughout the year.

The $25,000 maximum amount is reduced, but not below zero, by 50% of the amount by which your adjusted gross income exceeds $100,000. Therefore, the $25,000 is completely phased out when modified adjusted gross income reaches $150,000.

I suspect your modified adjusted gross income is above $150,000 and you may be totally phased out for an active participation rental loss.

Please note that there are special rules for real estate professionals. Also, the deductibility of rental losses may further be affected by “at risk” rules.

I suggest that you discuss your plans with your income tax return preparer before purchasing any rental properties so that you make educated economic decisions.

Barry Dolowich is a certified public accountant and owner of a full-service accounting and tax practice with offices in Monterey. He can be reached at (831) 372-7200. Please address any questions to Barry at PO Box 710 Monterey, CA 93942 or email bdolowich@gmail.com.