Verified answer

OozingCyst has an excellent answer, except for one technicality. When you sell a property with accumulated suspended losses, those losses are not added to the basis of the property, but instead they are simply released as ordinary loss. And there is a difference between these two treatments, with ordinary loss being better for you.

He also raised a very valid point that one person may not file a partnership. You will need your spouse as a partner or somebody else as a partner. If you do not mind major complications, you could in theory partner with your own corporation, but I do not recommend this controversial route.

Now, let's return to the fundamentals and clarify. You're right about $150k limitation for taking losses. The reason is that the IRS considers rental property to be "passive activity", and there're special rules limiting passive activity losses. Since my business is focused on real estate tax law and most of my clients are real estate investors, I have heard many so-called "gurus" promoting the idea that you can detour passive-activity limitations with partnerships. Worse, I have seen a lot of tax returns (prepared by CPAs, sadly) where these losses are indeed recorded on a partnership return and ultimately deducted on the personal return.

They are on the wrong side of legal, however. What they disregard is a very important, in fact fundamental, concept of the tax law: you simply may NOT change the nature of taxable income. If it's passive, then it is passive, period. Whether inside corporation, partnership, or directly on personal return - no difference.

Why then are the losses "allowed" on these erroneous partnership returns that some of your friends may be bragging about? Because they unknowingly (and sometimes knowingly) mis-classify rental activity as ordinary business activity. If you do that, the losses LOOK LIKE business losses (Line 1 of Schedule K-1) while they should be reported as rental losses (Line 2 of Schedule K-1). And inside partnership returns, they should be using Form 8825 which is partnership's version of personal Schedule E. Many landlords and even their CPAs never heard of this form. So, by putting numbers in the wrong places of the partnership return and then checking the wrong checkboxes on the personal return, the scheme seems to "work." Only until you're caught, though.

Short version: there is no LEGAL way to sidestep passive loss limitations, other than qualifying as a real estate professional, as you mentioned.

And, as you know, the unused losses are not wasted. They are accumulated until you sell. At that point, you can catch up.

Michael Plaks, EA, Houston TX

Specializing in real estate tax law

www.MichaelPlaks.com

Partnership Rental Income

2

So, who is your partner? Without a business partner, no partnership exists.

Even if you had a partner and spit the profits/losses equally, you'd still be up against the passive activity loss limitations due to your income. A partnership is a pass-through entity and is not taxed itself. Your rental income or loss would pass via Schedule K-1 to Schedule E just as if the partnership did not exist. All passive activity loss limitations would apply either way.

It's not all lost, however. Any passive activity losses that cannot be taken are carried forward. If you can use them in a future year, you use them. If you can't you continue the carry forward until you eventually dispose of the property. At that time, you add any unused passive losses to your basis when determining your gain or loss on the sale of the property and pick up any tax benefit there.

not if the rental property is not part of the Partnership, no