Dear Tax Talk,
I need clarification on the ability to claim losses with rental property. We have two properties that we started renting in 2010. One was vacant for five months, the other for only a month. We jointly own 100%, and spent about 1,000 hours managing and upgrading the properties. Our regular jobs are not in real estate. It looks like a loss of about $8,000 on the properties. I don't fully understand the passive or active management part.
-- Bruce

Dear Bruce,
To prevent taxpayers form sheltering business income with nonbusiness activities, Congress created passive activity loss rules. A passive activity is an activity in which the taxpayers do not materially participate. By definition, it includes all rental activities, whether or not a taxpayer materially participates.

In general, you can deduct passive activity losses only from passive activity income. You carry any excess loss forward to the following year or years until used, or until deducted in the year you dispose of your entire interest in the activity in a fully taxable transaction.