For the 2025 U.S. federal tax year, an individual actively participates (but is not a real estate professional) in a rental real estate activity that produces a loss, and has modified adjusted gross income (MAGI) of $120,000. Under the passive activity loss rules, how does the $25,000 special allowance apply?
- The special allowance is unavailable because MAGI exceeding the $100,000 threshold entirely eliminates it
- The full $25,000 special allowance applies regardless of MAGI, since active participation removes any income-based limitation
- The special allowance is capped at $12,500 for all single taxpayers regardless of income, since married-filing-separately limits do not apply to them
- The $25,000 special allowance is reduced by 50% of the amount by which MAGI exceeds $100,000, so at $120,000 of MAGI the allowance is reduced by $10,000 to $15,000
Why D? And why not the others?
Correct answer: D. The $25,000 special allowance is reduced by 50% of the amount by which MAGI exceeds $100,000, so at $120,000 of MAGI the allowance is reduced by $10,000 to $15,000
The $25,000 special allowance for rental real estate losses of an actively participating individual is reduced by 50% of the amount by which MAGI exceeds $100,000; at $120,000 of MAGI, the excess is $20,000, so the allowance is reduced by $10,000 (50% of $20,000), leaving $15,000 that can offset nonpassive income. The option claiming the allowance is unavailable once MAGI exceeds $100,000 is wrong because $100,000 is only the point at which the phase-out begins, not where the allowance is fully eliminated; the allowance does not disappear completely until MAGI reaches $150,000. The option claiming the full $25,000 always applies for an active participant is wrong because active participation is what makes the allowance available at all — as opposed to full real-estate-professional status, which removes the passive-loss limitation entirely — but active participation alone does not exempt the taxpayer from the MAGI-based phase-out of that allowance. The option describing a flat $12,500 cap for all single taxpayers is wrong because $12,500 is specifically the maximum allowance for a married taxpayer filing separately who lived apart from their spouse all year, not a limit that applies to single filers.
Source: IRS Publication 925 (2025), Passive Activity and At-Risk Rules; IRS Instructions for Form 8582