For the 2025 U.S. federal tax year, an individual owns several rental properties that generate a tax loss, materially participates in each rental activity, spends more than 750 hours during the year performing personal services in real property trades or businesses in which they materially participate, and this time is more than half of all personal services the individual performs in any trade or business during the year. Under IRC Section 469(c)(7), how are the individual's rental losses treated, and how does this differ from the $25,000 special allowance available to a merely active (but not materially participating) rental owner?
- The individual qualifies as a real estate professional, so the rental activities are not automatically treated as passive, and the resulting losses may offset the individual's other nonpassive income in full, with no $25,000 cap and no phase-out based on modified adjusted gross income, unlike the narrower special allowance, which applies only to a taxpayer who actively but not materially participates and phases out entirely once MAGI reaches $150,000
- The individual receives the same $25,000 special allowance as a merely active rental owner, because IRC Section 469(c)(7) only doubles the special allowance to $50,000 rather than removing the passive characterization altogether
- The individual's rental losses remain fully passive and nondeductible against nonpassive income in 2025, because real property trades or businesses are categorically excluded from the real estate professional exception regardless of hours worked
- The individual's rental losses are treated as passive unless the individual also owns at least a 10% interest in each rental activity, a requirement that applies equally to the real estate professional exception and to the $25,000 special allowance
Why A? And why not the others?
Correct answer: A. The individual qualifies as a real estate professional, so the rental activities are not automatically treated as passive, and the resulting losses may offset the individual's other nonpassive income in full, with no $25,000 cap and no phase-out based on modified adjusted gross income, unlike the narrower special allowance, which applies only to a taxpayer who actively but not materially participates and phases out entirely once MAGI reaches $150,000
IRC Section 469(c)(7) provides that a taxpayer who performs more than 750 hours of personal services during the year in real property trades or businesses in which they materially participate, where that time exceeds half of all personal services performed in any trade or business, qualifies as a real estate professional; for each rental real estate activity in which the taxpayer also materially participates, that activity is removed from the automatic passive-activity characterization entirely, so losses can offset wages, portfolio income, or any other nonpassive income without the $25,000 cap or the MAGI-based phase-out that applies to the separate special allowance under Section 469(i), which is available only to an actively (but not materially) participating owner and phases out completely once MAGI reaches $150,000. The option describing a doubled $50,000 allowance is wrong because Section 469(c)(7) does not enlarge the special allowance; it instead removes the passive characterization for a qualifying real estate professional's material-participation activities altogether. The option categorically excluding real property trades or businesses is wrong because Section 469(c)(7) exists specifically to let qualifying real estate professionals escape the passive characterization that would otherwise apply to rental real estate. The option imposing a 10% ownership-interest requirement on both provisions is wrong because that ownership threshold is a feature of the active-participation standard under Section 469(i), not a requirement of the real estate professional exception itself.
Source: IRS Publication 925 (2025), Passive Activity and At-Risk Rules (irs.gov/pub/irs-pdf/p925.pdf)