A rental activity is a passive activity even if you materially participated in that activity, unless you materially participated as a real estate professional.
Per IRS Publication 925 Passive Activity and At-Risk Rules, page 4:
Phaseout rule. The maximum special allowance of $25,000 ($12,500 for married individuals filing separate returns and living apart at all times during the year) is reduced by 50% of the amount of your modified adjusted gross income that’s more than $100,000 ($50,000 if you’re married filing separately). If your modified adjusted gross income is $150,000 or more ($75,000 or more if you’re married filing separately), you generally can’t use the special allowance. This is because the special allowance is reduced to $0 since the modified adjusted gross income is over the $100,000 amount.
Modified adjusted gross income for this purpose is your adjusted gross income figured without the following.
- Taxable social security and tier 1 railroad retirement benefits.
- Deductible contributions to individual retirement accounts (IRAs) and section 501(c)(18) pension plans.
- The exclusion from income of interest from qualified U.S. savings bonds used to pay qualified higher education expenses.
- The exclusion from income of amounts received from an employer’s adoption assistance program.
- Passive activity income or loss included on Form 8582.
- Any rental real estate loss allowed because you materially participated in the rental activity as a Real Estate Professional (as discussed later, under Activities That Aren't Passive Activities).
- Any overall loss from a publicly traded partnership (see Publicly Traded Partnerships (PTPs) in the Instructions for Form 8582).
- The deduction allowed for the deductible part of self-employment tax.
- The deduction for domestic production activities.
- The deduction allowed for interest on student loans.
- The deduction for qualified tuition and related expenses.
At the time this Publication went to print, the tuition and fees deduction that would've been excluded in calculating modified adjusted gross income had expired. To find out if legislation extended the deduction, go to IRS.gov/Pub925
Exceptions to the phaseout rules. A higher phaseout range applies to rehabilitation investment credits from rental real estate activities. For those credits, the phaseout of the $25,000 special allowance starts when your modified adjusted gross income exceeds $200,000 ($100,000 if you’re a married individual filing a separate return and living apart at all times during the year).
There is no phaseout of the $25,000 special allowance for low-income housing credits or for the CRD.
Ordering Rules. If you have more than one of the exceptions to the phaseout rules in the same tax year, you must apply the $25,000 phaseout against your passive activity losses and credits in the following order.
- The portion of passive activity losses not attributable to the CRD.
- The portion of passive activity losses attributable to the CRD.
- The portion of passive activity credits attributable to credits other than the rehabilitation and low-income housing credits.
- The portion of passive activity credits attributable to the rehabilitation credit.
- The portion of passive activity credits attributable to the low-income housing credit