In business, you can earn active or passive income. Active income occurs when you perform work that brings in money. Passive income is paid to you based on something you own. A good example of passive income is rent payments from rental property you own. Passive income creates tax implications for you. Investors turn to real estate as a way to build long-term wealth, earn additional income, and generate a tax shelter. Using real estate as a tax shelter that extends to other income can be a complicated process.
Knowing how you can use any losses generated by your rental real estate starts with understanding how the IRS IRC section 469 states that a taxpayer can use losses from a passive activity only to offset passive activity income. In other words, passive losses cannot shelter active income such as salaries, commissions, wages or portfolio income such as interest, dividend or annuity income. Generally, a passive activity is any rental activity OR any business in which the taxpayer does not materially participate. Nonpassive activities are businesses in which the taxpayer works on a regular, continuous, and substantial basis. In addition, passive income does not include salaries, portfolio, You may be subject to the Net Investment Income Tax (NIIT). NIIT is a 3.8% tax on the lesser of net investment income or the excess of modified adjusted gross income (MAGI) over the threshold amount.