The short answer
A loss from renting out property is usually a passive loss, and passive losses can generally offset only passive income — not your wages or business income. Two main exceptions exist: the $25,000 special allowance for owners who actively participate, which phases out between $100,000 and $150,000 of modified AGI, and real estate professional status combined with material participation. Losses you cannot use are carried forward, not lost.
Four questions, in order
| Question | Why it matters |
|---|---|
| 1. Is it a "rental activity" under the passive rules? | Long-term rentals usually are. An average customer stay of 7 days or less (or 30 days or less with significant personal services) is not a rental activity — it is tested like a business instead |
| 2. Is the activity passive? | A rental activity is passive even if you work hard at it, unless you are a real estate professional who materially participates. A non-rental activity is passive unless you materially participate |
| 3. Does an exception let you deduct a passive rental loss? | The $25,000 special allowance for active participation in rental real estate, subject to the modified AGI phaseout |
| 4. What happens to the rest? | It is suspended and carried forward on Form 8582 |
Active participation vs. material participation
| Active participation | Material participation | |
|---|---|---|
| Used for | The $25,000 special allowance for rental real estate | Making a trade or business activity nonpassive, and making a real estate professional's rental nonpassive |
| Standard | Less strict: making management decisions in a significant and bona fide sense, such as approving tenants, setting rental terms, and approving expenditures | Strict: you must meet one of seven tests |
| Ownership | You (with your spouse) must own at least 10% of the activity by value all year | No minimum ownership percentage in the tests |
The seven material participation tests in Publication 925 include:
- More than 500 hours of participation during the year.
- Your participation was substantially all of the participation of all individuals, including non-owners.
- More than 100 hours, and at least as much as any other individual.
- Significant participation activities (more than 100 hours each) totaling more than 500 hours.
- Material participation in any 5 of the 10 immediately preceding years.
- A personal service activity in which you materially participated in any 3 preceding years.
- Regular, continuous, and substantial participation based on all the facts — not available if you participated 100 hours or less, and with limits on counting management work.
The $25,000 special allowance and the phaseout
| Filing status | Maximum allowance | Phaseout begins (modified AGI) | Fully phased out |
|---|---|---|---|
| Single, head of household, married filing jointly | $25,000 | Over $100,000 | $150,000 or more |
| Married filing separately, lived apart all year | $12,500 | Over $50,000 | $75,000 or more |
| Married filing separately, lived together at any time | None | — | — |
- The allowance is reduced by 50% of modified AGI over the threshold. For example, at $120,000 of modified AGI, the maximum allowance is $15,000.
- Modified AGI here is figured without certain items, including taxable Social Security benefits, deductible IRA contributions, and passive activity income or loss.
- These amounts are set by statute and are not adjusted for inflation; they are the same for 2025 and 2026.
Real estate professionals
- Two tests for the year: more than half of all your personal services in all trades or businesses were in real property trades or businesses in which you materially participated, and you performed more than 750 hours of services in those real property trades or businesses.
- Employee hours in real estate do not count unless you own more than 5% of the employer.
- Joint returns: one spouse must meet both tests alone, although the other spouse's work can count toward material participation.
- Not automatic: even after qualifying, each rental is nonpassive only if you materially participate in it. Each interest in rental real estate is a separate activity unless you elect to treat all interests as one activity (see the Instructions for Schedule E).
Short-term rentals
If the average customer stay is 7 days or less, or 30 days or less and you provide significant personal services, the activity is not a rental activity under the passive rules. That removes it from the "rental is always passive" rule, but it does not make the loss nonpassive by itself. The activity is passive unless you materially participate under one of the seven tests, and the $25,000 rental allowance does not apply to it. A separate rule applies if you also used the home personally for more than the greater of 14 days or 10% of the days it was rented at a fair price — see the 14-day rule.
Suspended losses
- Disallowed passive losses carry forward to the next year and can offset passive income then.
- When you dispose of your entire interest in the activity in a fully taxable transaction to an unrelated person, suspended losses from it are generally allowed in full.
- Keep your Forms 8582 and worksheets each year so you can track the carryforward.
Examples (2025)
| Grace | David | Mei | |
|---|---|---|---|
| Facts | Single, $90,000 wages, $12,000 loss on a long-term rental she manages herself | Married filing jointly, $135,000 modified AGI, $20,000 rental loss, actively participates | Single, $180,000 wages, $18,000 loss on a short-term rental with a 4-night average stay; she works 60 hours, while a property manager and cleaners work more |
| Result | Deducts all $12,000 — under the $25,000 allowance and below the phaseout | Allowance reduced to $7,500 ($25,000 − 50% × $35,000); $12,500 is suspended | Not a rental activity, but no material participation test is met, so the loss is passive and suspended |
Material participation and real estate professional status depend on hours you can prove. Keep a contemporaneous log of dates, hours, and tasks. Claiming nonpassive treatment without records is a common audit issue.