Can I deduct rental property loss against dividend/capital gains income?

Thanks for explaining this! I'm definitely under the MAGI threshold, but what exactly counts as "actively participating" in the rental? I do handle finding tenants, collecting rent, and arranging repairs - just don't do the repairs myself. Would that be considered active participation? Also, does the $25,000 limit apply even if my actual passive loss is higher due to the large depreciation deduction?

Yes, what you're describing would typically qualify as active participation! Active participation means making management decisions like approving tenants, setting rental terms, approving repairs, etc. - you don't need to do the physical work yourself or even spend a substantial amount of time on it. The $25,000 limit is a maximum ceiling on what you can deduct against non-passive income, regardless of how large your actual passive loss is. So if your depreciation creates a $40,000 loss, you could potentially use $25,000 against your other income and then carry forward the remaining $15,000 to future tax years where you have passive income or meet the exception again.

How does it work with the stepped-up basis specifically? My dad left me a property and I'm trying to figure out if I'm calculating the depreciation correctly based on the new basis.

I'm skeptical about these online tools. How does it actually determine if you qualify as a real estate professional? Doesn't that require tracking specific hours and activities that a computer program wouldn't know?

For stepped-up basis properties, it walks you through separating the land value from the building value since only the building portion can be depreciated. It then helps you calculate the correct depreciation schedule based on the stepped-up value and property type. Regarding tracking hours, that's actually one of the most useful features. It has a system where you can upload documentation of your activities (calendars, emails, maintenance logs, etc.) and it helps categorize which activities count toward the 750-hour requirement for real estate professional status. It doesn't make the determination automatically - it guides you through the process and helps you document everything properly so you have substantiation if you're ever audited.

How does this actually work? Does it just keep calling the IRS for you or something? I've spent literal hours on hold and eventually just gave up.

Sounds too good to be true. The IRS is notoriously impossible to reach by phone. Are you sure you actually spoke with an official IRS agent and not some third-party service giving you tax advice?

It uses a system that navigates the IRS phone tree and waits on hold for you. When an actual IRS agent picks up, you get a call back so you can talk directly to them. You're not paying for tax advice - you're paying for the service to wait on hold instead of you doing it yourself. And yes, it was definitely an actual IRS agent. They had access to my tax records and were able to make notes in my account about our conversation. The agent gave me their ID number and everything, which is standard IRS procedure. It's just a way to get through the hold times - once connected, it's a regular conversation with an official IRS representative.

Are there any drawbacks to cost segregation? I've heard it can cause issues when you eventually sell the property.

The main drawback is that when you sell the property, any depreciation you've taken (accelerated or otherwise) is "recaptured" and taxed at a 25% rate rather than capital gains rates. So you're essentially trading tax savings now for potentially higher taxes later. Also, a proper cost segregation study can be expensive - usually several thousand dollars - so it might not be worth it for smaller properties. You need to run the numbers to see if the present value of the tax savings exceeds the cost of the study and any future tax implications.

Thanks for bringing this up! What are the requirements to qualify as a real estate professional? I have a full-time job in finance, so I'm guessing I probably wouldn't qualify?

To qualify as a real estate professional, you need to meet two tests: (1) more than half of your personal services during the year are performed in real property trades or businesses, AND (2) you perform more than 750 hours of services during the year in real property trades or businesses in which you materially participate. Since you have a full-time job in finance, you're right that it would be very difficult to qualify. You'd need to spend more hours on real estate activities than your finance job, which isn't realistic for most people with traditional careers. The active participation exception with the $25,000 limit is probably your best bet given your situation.

This is really helpful advice! I'm curious about the property appraisal aspect you mentioned. When you inherit property with a stepped-up basis, do you need to get a new appraisal specifically for tax purposes, or can you use the appraisal that was done for estate/probate purposes? I want to make sure I'm allocating the land vs building value correctly from the beginning rather than having to fix it later.

Great question about the appraisal! You can typically use the estate appraisal that was done for probate purposes to establish your stepped-up basis, as long as it was done close to the date of death. However, you'll want to make sure that appraisal specifically breaks down the allocation between land value and building/improvements value, since only the building portion is depreciable. If the estate appraisal doesn't provide this breakdown, or if it's been a while since the original appraisal, you might want to get a new one specifically for tax purposes. Some appraisers can also provide a "desktop" or "drive-by" appraisal that's less expensive than a full appraisal but still gives you the land/building allocation you need. The key is having solid documentation to support your depreciation calculations, especially with such a high-value property. The IRS tends to scrutinize large depreciation deductions, so having a professional appraisal that clearly shows how you arrived at your depreciable basis will be valuable protection if you're ever audited.

This is really valuable information about the timing aspect! I hadn't considered that the depreciation clock doesn't start ticking until the property is actually placed in service as a rental. In my case, I inherited the property in late 2023 but it took me a few months to get it ready for tenants and find the first renter, so I didn't start collecting rent until early 2024. Does this mean I can only claim depreciation starting from when I got my first tenant, or from when the property was ready and available for rent? Also, with such a large depreciation amount relative to rental income, I'm wondering if there are any red flags I should be aware of that might trigger an IRS audit. Having proper documentation seems crucial, but are there any other best practices for staying compliant when your depreciation significantly exceeds rental income?

Great question about the "placed in service" timing! The property is considered placed in service when it's available and ready for rent, not necessarily when you get your first tenant. So if you had the property ready and advertised for rent in early 2024, that's when depreciation would begin, even if it took a few weeks to find a tenant. Regarding audit red flags with large depreciation relative to rental income - this is actually quite common with inherited properties due to stepped-up basis, so it's not automatically suspicious. The key things that help avoid issues: (1) have a solid appraisal supporting your basis and land/building allocation, (2) keep detailed records of all rental activities to support active participation, (3) make sure your rental income and expenses are reasonable and well-documented, and (4) consider getting professional help with the depreciation calculation. The IRS is more concerned with inflated basis or improper depreciation methods than with legitimate large depreciation amounts from inherited property. Your situation is actually textbook for why stepped-up basis exists - to reflect current fair market value rather than the original owner's historical cost.

This is extremely helpful information about Form 8582 and the documentation requirements! I'm just getting started with rental property taxation and feeling overwhelmed by all the rules and forms involved. One question about the timing strategy you mentioned - if I'm already expecting significant capital gains this year from some stock sales I had planned, would it make sense to defer those sales to next year to stay below the MAGI threshold? Or are there other considerations I should factor in beyond just the passive loss rules? Also, your point about the spreadsheet for tracking rental activities is great advice. Do you have any specific categories or types of activities that are most important to document for proving active participation? I want to make sure I'm capturing the right information from the start rather than trying to reconstruct it later.