$25,000 Rental Loss Allowance and the $100k-$150k Phase-Out
If you actively participate in your rentals, you can deduct up to $25,000 of rental real estate losses a year against your salary, pension or other nonpassive income (§469(i)(2)). The allowance shrinks by 50 cents for every dollar of modified adjusted gross income over $100,000 and is gone at $150,000 (§469(i)(3)(A)). Above that, rental losses are passive and carry forward on Form 8582.
The rule in one table
| Modified AGI | Allowance | How it is figured |
|---|---|---|
| $100,000 or less | $25,000 | Full allowance |
| $110,000 | $20,000 | $25,000 - 50% x $10,000 |
| $120,000 | $15,000 | $25,000 - 50% x $20,000 |
| $130,000 | $10,000 | $25,000 - 50% x $30,000 |
| $140,000 | $5,000 | $25,000 - 50% x $40,000 |
| $150,000 or more | $0 | Fully phased out |
The statute: the $25,000 "shall be reduced (but not below zero) by 50 percent of the amount by which the adjusted gross income of the taxpayer for the taxable year exceeds $100,000" (§469(i)(3)(A)). The $25,000 is the same for single and joint filers. It is not doubled on a joint return.
Why rental losses need an allowance at all
Rental activity is passive by definition. "The term 'passive activity' includes any rental activity" (§469(c)(2)), no matter how many hours you put in, unless you qualify as a real estate professional. Passive losses can only offset passive income (§469(d)(1)).
Congress softened that for moderate-income landlords who manage their own property. The $25,000 allowance is the only way a regular landlord's rental loss reaches wages without selling the property.
Who qualifies: active participation
The allowance applies to "rental real estate activities with respect to which such individual actively participated" (§469(i)(1)). Active participation is not defined by hours. In practice it means you make real management decisions: approving tenants, setting rents, approving repairs and capital spending. A property manager can do the day-to-day work if you still make those calls.
The statute adds three hard limits:
- At least 10% ownership. You are not an active participant for any period in which your interest, including your spouse's, "is less than 10 percent (by value) of all interests in such activity" (§469(i)(6)(A)).
- No limited partners. "No interest as a limited partner in a limited partnership shall be treated as an interest with respect to which the taxpayer actively participates," except as regulations provide (§469(i)(6)(C)). Syndication LPs never get the allowance. See syndication K-1 losses.
- Spouse counts. "In determining whether a taxpayer actively participates, the participation of the spouse of the taxpayer shall be taken into account" (§469(i)(6)(D)).
Active participation vs material participation
The two tests are easy to confuse. They do different jobs.
| Active participation | Material participation | |
|---|---|---|
| Where it matters | The $25,000 allowance (§469(i)) | Whether a business is passive (§469(h)); whether a real estate professional's rental is nonpassive |
| Standard | Bona fide management decisions | Regular, continuous and substantial involvement; seven tests in Temp. Reg. §1.469-5T(a) |
| Hours needed | No hours test | Usually more than 100 or more than 500 hours |
| Ownership | At least 10% by value | No ownership floor |
| Limited partners | Never | Only three of the seven tests (Temp. Reg. §1.469-5T(e)(2)) |
| Income limit | Phases out $100,000 to $150,000 | None |
The detail of the seven tests is in material participation for rentals.
What counts as modified AGI for the phase-out
The phase-out uses adjusted gross income with a few adjustments. Under §469(i)(3)(E), AGI is determined without regard to:
- the taxable part of Social Security benefits (§86),
- the exclusions under §§85(c), 135 and 137 (so that income is counted),
- deductions under §§219 (IRA contributions), 221 (student loan interest) and 250, and
- "any passive activity loss or any loss allowable by reason of subsection (c)(7)."
The last item matters. You do not get to use the rental loss itself to push your income under $100,000.
Simple example: partial allowance
Simple example (2026, married filing jointly, federal income tax only). A couple has modified AGI of $120,000 from wages, takes the $32,200 standard deduction, and actively participates in two rentals that produce a $30,000 net loss.
- Allowance: $25,000 - 50% x ($120,000 - $100,000) = $15,000.
- Deductible rental loss this year: $15,000.
- Carried forward on Form 8582: $15,000.
| Taxable income | Federal tax | |
|---|---|---|
| Without the rental loss | $87,800 | $10,040 |
| With $15,000 allowed | $72,800 | $8,240 |
The allowance saves $1,800 this year, the 12% bracket on $15,000 (2026 brackets, Rev. Proc. 2025-32). At $150,000 of modified AGI, the same couple would deduct nothing and carry the whole $30,000 forward.
Married filing separately
Separate filers get a harsh version. If you file separately and lived apart from your spouse at all times during the year, the statute substitutes "$12,500" for "$25,000" and "$50,000" for "$100,000" (§469(i)(5)(A)), so the allowance is gone at $75,000. If you did not live apart at all times during the year, the allowance "shall not apply" at all (§469(i)(5)(B)).
In Oderio v. Commissioner, T.C. Memo. 2014-39, a married taxpayer filing separately got no §469(i) allowance because she was married and living with her spouse, and a §6662(a) penalty was sustained.
When the IRS denies real estate professional status, the allowance can survive
Owners who claim real estate professional status and lose sometimes still keep part of the loss through the allowance. In Escalante v. Commissioner, T.C. Summ. Op. 2015-47, the IRS denied the teacher's REP claim but allowed the §469(i) allowance: $25,000 for 2006 and 2007, and $19,000 for 2005 after the phase-out. In Ostrom v. Commissioner, T.C. Memo. 2017-118, a full-time IT specialist with four self-managed rentals lost REP status, and the IRS allowed the $25,000 active participation allowance. These are not precedent for your facts, but they show the two tests are separate.
Why the allowance vanishes in the year you sell
Here is the part owners miss. Gain on selling a rental counts in AGI. A $300,000 gain pushes almost any household above $150,000, so in the year of sale the allowance is usually zero.
That does not matter much if you sell the entire property to an unrelated buyer in a taxable sale, because §469(g) releases that property's suspended losses anyway. It matters more on an installment sale: every year the recognized gain lifts AGI, so the $25,000 allowance for the rentals you keep is likely gone in every payout year. Plan the rentals you keep and the one you sell together. See suspended passive losses when you sell and installment sales and passive losses.
If you are over $150,000
Most high earners get no allowance. Their options are the other doors in §469: passive income, a qualifying spouse, a short-term rental they materially participate in, or a sale of the entire activity. The map is in Section 469 passive activity rules, and the physician version is in passive losses for doctors.
Bottom line
The $25,000 allowance is real money for landlords with modified AGI under $150,000 who make their own management decisions and own at least 10%. It is zero for limited partners, for most high earners and, often, in the year you sell. Losses it does not cover are not lost; they carry forward to the day you sell. The Waterfall Strategy is about that day.
Questions to ask your CPA
- What is my modified AGI for the §469(i) phase-out, and what items were removed?
- Do I actively participate in each rental and own at least 10% of it?
- How much of this year's rental loss was allowed, and how much carried forward?
- If I sell one rental, what happens to the allowance for the ones I keep, this year and in any installment years?
- What does the California Form 3801 show compared with the federal Form 8582?
Get the full playbook. The Waterfall Strategy, the 20-minute version and the one-page Cliff Notes, free.
Educational only, not tax, legal or investment advice. Examples are illustrative. Have your CPA or tax attorney review your facts before you act. Hans Goldstein is a licensed insurance agent (CA Insurance License #4273294) and is not a CPA or attorney. He is paid a commission only if a structured installment sale is funded; seller financing pays him nothing. Disclosures.