Is all passive income treated the same?

Question

Wondering if losses from passive rental income (I.e. long distance property managed by third party) could offset capital gains from stocks?

Michael Plaks · Answer

Your question was whether all passive income is treated the same. The problem is that we need to be careful with the word "passive" because it has a very specific meaning in the tax law, and it is not intuitive.

For example, losses from rental properties are usually passive but not always, there are some exceptions. Losses from investing in partnerships are usually passive but not always. And so on. Sorry, it really is complicated, and I did not write these laws.

Capital gains from stocks are never passive. They are classified as portfolio income. Because losses from rentals and income from stocks fall into two different buckets, they cannot directly offset each other.

Notice I said directly. If your overall income, including capital gains, is low enough (under $150k), you may still benefit from rental losses. It will not be a direct offset of capital gains but an offset of your other income.

Ashish Acharya · Answer

@Sherry T. No, not all passive income is treated the same, and rental losses generally cannot offset capital gains from stocks due to passive activity loss (PAL) rules. Rental income is considered passive, while stock market capital gains are portfolio income, meaning passive losses from rentals can only offset other passive income, not capital gains. However, exceptions exist. If your MAGI is below $100K, you may deduct up to $25K of passive rental losses against non-passive income, phasing out at $150K+. Real Estate Professional Status (REPS) or material participation in a short-term rental (STR) could allow rental losses to offset capital gains.  Alternative strategies include tax-loss harvesting to offset stock gains, using cost segregation and bonus depreciation for real estate deductions, or deferring real estate capital gains through a 1031 exchange. Consulting a real estate tax expert can help optimize tax benefits.This post does not create a CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.

Basit Siddiqi · Answer

If you have active participation in the rentals and your income is below $150,000, you might be able to deduct some rental losses which could help you with your other income such as capital gains.

Sherry T. · Answer

Thank you @Ashish Acharya, @Basit Siddiqi, @Michael Plaks and @Sean Graham for your helpful responses!

Is all passive income treated the same?

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