TP owns a residential condominium unit that he rents to tenants. TP purchased th

Question

TP owns a residential condominium unit that he rents to tenants. TP purchased the condo several years ago, paying $50,000 of his own savings, and $150,000 borrowed from a local bank. Interest only is payable on the recourse loan at 7% per year.

Over the course of the year, TP received rent payments from tenants of $20,000, but he also incurred a number of expenses. He had interest payments of $10,500, condo fees of $2,000, real estate taxes of $1,500, insurance premiums of $1,000, and miscellaneous repair and service costs of $500. Consequently, TP's out of pocket expenses totaled $15,500, leaving him with a positive cash flow from the property of $4,500 ($20,000 rental payments - $15,500 expenses).

In addition, because TP was entitled to depreciation deductions with respect to the condo of $7,300, he had total deductions for tax purposes of $22,800.

If TP instead earned his $160,000 salary through his work for a real estate management company in which he spent 1,800 hours during the taxable year, how much of the expenses associated with the condo would TP be entitled to deduct under the passive activity rules?

Select one:

A. None because TP did not materially participate

B. Only $20,000 because a rental activity is a passive activity and TP had no passive income other than $20,000 in rents from the condo

C. $22,800 because TP had passive income of $20,000 in rents from the condo and $8,000 in income from consulting fees

D. $22,800 because TP materially participated in the rental activity

Explanation / Answer

Only $20,000 because a rental activity is a passive activity and TP had no passive income other than $20,000 in rents from the condo. Generally, rental activities are passive activities even if you materially participated in them. However, if you qualified as a real estate professional, rental real estate activities in which you materially participated aren’t passive activities. For this purpose, each interest you have in a rental real estate activity is a separate activity, unless you choose to treat all interests in rental real estate activities as one activity. so thats why deduction for rental activity allowed upto revenue from rental activity. in other words, no passive activity losses allowed.

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