Can You Deduct Rental Losses From Income: $25K Allowance & Exceptions

In most cases you can deduct rental losses from your other income, but the amount is capped. If you actively participate in managing the property and your modified adjusted gross income is $100,000 or less, you can deduct up to $25,000 of rental losses each year against wages, interest, and other non-passive income. The allowance shrinks between $100,000 and $150,000 of MAGI and disappears above that. Losses you cannot use in the current year carry forward and are released when you sell the property.

Why the Deduction Is Capped in the First Place

Federal tax law classifies almost all rental real estate as a passive activity, regardless of how many hours you put in.¹ Passive losses normally offset only passive income, such as profits from other rentals or from limited partnerships. They do not, as a default rule, offset your salary, business income, or portfolio income like dividends and interest.

Everything below is either an exception to that default or a further limit stacked on top of it. Which ones apply to you depends on your income, how you use the property, and how involved you are.

The $25,000 Special Allowance

The exception most landlords rely on lets you deduct up to $25,000 of rental losses against non-passive income each year, provided you actively participated in the rental.²

Active participation is not a high bar. If you approve tenants, set rent, or decide when repairs get made, you qualify. There is no minimum hour requirement, and you can still use a property manager as long as you keep authority over the major decisions.

The Income Phase-Out

You get the full $25,000 when your modified adjusted gross income is $100,000 or less. For every dollar of MAGI above $100,000, the allowance drops by 50 cents. At $150,000 of MAGI, the allowance is zero and the general passive loss rules take over.²

The MAGI used here starts with adjusted gross income and adds back the passive loss itself, taxable Social Security or railroad retirement benefits, deductible IRA contributions, the deductible portion of self-employment tax, the student loan interest deduction, and the exclusion for savings bond interest used for education.³ Because the rental loss is stripped out before the calculation, the loss cannot push you into the phase-out range on its own.

If You’re Married Filing Separately

Filing a separate return cuts the allowance sharply. The maximum drops to $12,500, and only if you lived apart from your spouse for the entire year. If you lived together at any point, the allowance is zero. The phase-out also begins at $50,000 of MAGI instead of $100,000.³ For most married couples, filing jointly is the only way to reach the full $25,000.

What Happens to Losses You Can’t Use This Year

Rental losses that exceed what you can deduct in a given year are not lost. They become suspended losses and carry forward automatically to every future year until they can be absorbed.¹ There are two ways they eventually come off the shelf.

First, if you generate passive income in a later year, the suspended losses offset it. Second, and more consequential for most owners, when you sell the property in a fully taxable transaction to an unrelated buyer, all accumulated suspended losses from that property are released at once and treated as non-passive. They offset the gain from the sale first, then any wages, business income, or other income on your return that year. Sales to related parties, such as family members or entities you control, delay the release until the buyer later sells to an unrelated person.

This is why suspended losses are worth tracking carefully year after year. They pay off in the year you sell.

Two Ways to Escape the Passive Label Entirely

The $25,000 cap only matters if your rental is classified as passive. Two situations take the activity out of that box, and when they do, losses can offset any type of income without the $25,000 ceiling.

Real Estate Professional Status

If you qualify as a real estate professional, your rental activity is no longer automatically passive.¹ Two tests must be met every year:

More than half of your personal services during the year must be performed in real property businesses where you materially participate.
You must perform at least 750 hours of service in those real property businesses during the year.²

Qualifying gets you the label, but you still have to materially participate in each rental property, usually by spending more than 500 hours on it during the year. If you own several properties, you can elect to treat all of them as a single activity for material participation, which makes the hour totals easier to reach. That election is generally binding for future years.²

On a joint return, only one spouse needs to meet the 750-hour and majority-of-services tests, and you cannot combine spouses’ hours to get there.² Once one spouse qualifies, both spouses’ hours can be combined for the separate material participation test on each property.

The IRS looks hard at these claims. Keep a contemporaneous log with dates, hours, and the specific tasks performed. Logs reconstructed after the fact have been rejected repeatedly in Tax Court. If the hours cannot be proved, the losses get reclassified as passive, with back taxes and interest on the disallowed portion.

Short-Term Rentals With an Average Stay of 7 Days or Less

Property rented with an average guest stay of seven days or less is not treated as a rental activity at all for passive loss purposes.² For many Airbnb and vacation rental owners this is a major shift, because the activity leaves the automatic-passive box and becomes an ordinary trade or business. Losses are then non-passive if you materially participate.

Material participation for a short-term rental is most commonly established by spending more than 500 hours during the year on guest communication, bookings, cleaning, maintenance, and check-ins. Clear that bar and your losses can offset wages and other ordinary income, with no real estate professional status required and no $25,000 cap.² Hire a management company and stay hands-off, and the activity remains passive despite the short average stay.

When Personal Use Kills the Deduction

If you use the property personally for more than the greater of 14 days or 10 percent of the days it was rented at a fair price during the year, the IRS reclassifies it as a residence.⁴ Once that happens, rental expenses and depreciation are deductible only up to the amount of rental income. There is no loss to deduct against other income; any excess simply carries forward against future rental income from the same property.⁵ Shared expenses like mortgage interest, property taxes, and utilities must be prorated between rental and personal days.

A separate rule applies when you rent the property fewer than 15 days during the entire year: you don’t report the rental income, and you can’t deduct any rental-specific expenses. Mortgage interest and property taxes still work as personal itemized deductions on Schedule A, but no rental loss is possible.⁶

Two More Ceilings: At-Risk and Basis

Even after you clear the passive activity rules, two additional filters apply to every rental loss.

The at-risk rule limits your deductible loss to what you have financially at stake in the property. That includes the cash you invested, the adjusted basis of property you contributed, and any debt for which you are personally liable.⁷ Nonrecourse debt normally does not count. Real estate gets an important exception: qualified nonrecourse financing, meaning a loan from a bank or government entity secured only by the property itself, does count toward your at-risk amount.⁸ Most conventional rental mortgages qualify, so this rule rarely blocks a typical landlord. It matters more with seller financing or related-party loans.

Your basis in the property, essentially the purchase price plus improvements minus accumulated depreciation, is a separate ceiling. Losses cannot exceed adjusted basis, and any excess is suspended until you add to your basis, usually by putting more money in or paying down debt.

How to Report the Loss

Rental income and expenses for each property go on Schedule E (Form 1040), one property at a time.⁹ If you own more than three, attach additional copies. Deductible expenses include mortgage interest, property taxes, insurance, maintenance, advertising, and management fees. Depreciation for residential rental property is calculated over 27.5 years using the straight-line method, and it often creates or enlarges a paper loss even when the property is cash-flow positive.

Anytime losses are limited by the passive activity rules, you also file Form 8582 to calculate how much is currently deductible and how much carries forward.¹⁰ The allowed loss flows from Form 8582 back to Schedule E and then to your Form 1040. Most tax software handles the sequence for you.

Keep records supporting rental income and expenses for at least three years after filing, and hold them longer if you have carryover losses or a depreciation schedule that will span decades.¹¹ Losing track of suspended loss balances or depreciation history can cost real money at the point of sale.

1
Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited
2
Internal Revenue Service. Publication 925 (2025), Passive Activity and At-Risk Rules
3
Internal Revenue Service. Instructions for Form 8582 (2025)
4
Office of the Law Revision Counsel. 26 USC 280A – Disallowance of Certain Expenses in Connection With Business Use of Home, Rental of Vacation Homes, Etc.
5
Internal Revenue Service. Publication 527 (2025), Residential Rental Property (Including Rental of Vacation Homes)
6
Internal Revenue Service. Renting Residential and Vacation Property
7
Office of the Law Revision Counsel. 26 USC 465 – Deductions Limited to Amount at Risk
8
eCFR. 26 CFR 1.465-27 – Qualified Nonrecourse Financing
9
Internal Revenue Service. About Schedule E (Form 1040), Supplemental Income and Loss
10
Internal Revenue Service. About Form 8582, Passive Activity Loss Limitations
11
Internal Revenue Service. How Long Should I Keep Records?