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If you own a long-term rental, you are not a real estate professional, and your modified adjusted gross income is under $150,000, Section 469(i) lets you deduct up to $25,000 of rental losses a year against your salary and other ordinary income, as long as you actively participate in the rental. The catches come first: the allowance phases out by 50 cents for every dollar of income above $100,000 and is gone at $150,000, it is one allowance per return rather than per property, and it does not apply to a short-term rental with average stays of seven days or less. A cost segregation study is what gives the allowance something to work with, because without accelerated depreciation most rentals show a small profit on paper. With a study and 100 percent bonus, the same house can throw off a first-year loss several times larger than $25,000; the allowance decides how much you use now, and the rest carries forward.
Most cost segregation writing is aimed at two kinds of owners: real estate professionals who spend their working life on property, and high earners who materially participate in a vacation rental. Ben is neither. He is a single nurse practitioner in Appleton, Wisconsin, earning about $95,000 a year. In July 2025 he bought his first rental, a three-bedroom house on the north side that he leases to a family on a twelve-month lease. He picked the tenants, set the rent and approves every repair. He will never spend 750 hours a year on real estate, because he has a full-time career.
His CPA told him rental losses are passive, usable only against passive income, and he has none. That is true for most higher-income taxpayers. It leaves out the exception written for people exactly like Ben, and for a large share of the small landlords in this country. His numbers follow, first without a study and then with one, at three income levels. The figures are illustrative; the mechanics are the ones the IRS lays out in the Form 8582 instructions and Publication 925.
Section 469 is the passive activity loss rule. Congress adopted it in 1986 to stop paper losses from wiping out wages. A passive loss offsets passive income only; the excess suspends and carries forward. Two kinds of activity are passive by default: a business you do not materially participate in, and any rental activity, no matter how many hours you put in, with exceptions covered below. A long-term rental is passive by definition, so its depreciation, including the accelerated depreciation from a study, is passive too. That is why so many owners are told a study will not help them unless they are real estate professionals. Congress built a carve-out for small landlords.
Section 469(i) provides that an individual who actively participates in a rental real estate activity can deduct up to $25,000 of loss from all such activities against nonpassive income in the same year: wages, self-employment income, interest, dividends and capital gains. The rules around it:
MAGI here is adjusted gross income figured without any passive loss, with the deductible IRA contribution and student loan interest deduction added back and the taxable part of Social Security left out. Your CPA computes it on Form 8582. The test uses income before the rental loss, so a big study deduction cannot shrink the income being tested.
Subtract $100,000 from your MAGI, halve the excess, subtract that from $25,000:
| Your MAGI | Reduction | Allowance available |
|---|---|---|
| $100,000 or less | $0 | $25,000 |
| $110,000 | $5,000 | $20,000 |
| $120,000 | $10,000 | $15,000 |
| $130,000 | $15,000 | $10,000 |
| $140,000 | $20,000 | $5,000 |
| $150,000 or more | $25,000 | $0 |
Every extra $2 of MAGI in the phaseout range costs $1 of allowance. A bonus, a Roth conversion or a capital gain can quietly eat it. Steps that lower MAGI, such as larger pre-tax 401(k) deferrals, can restore part of it. Ask your CPA to run both versions before year end.
Active participation is easier than the material participation standard real estate professionals and short-term rental hosts have to meet. No hour count. You and your spouse own at least 10 percent of the property and take part in a bona fide way in management decisions: approving tenants, setting rental terms, approving expenditures. You can hire a property manager and still qualify as long as the major decisions run through you. A limited partner in a syndication generally does not qualify, which is why the allowance rarely helps K-1 investors. Keep a folder with the emails approving a tenant, the signed lease and the repair invoices you approved. That is usually enough.
Ben paid $420,000 for the house in July 2025. An appraisal and the county records support $70,000 of land, which comes out first, leaving $350,000 of depreciable basis. In his first partial year the house produced $9,000 of net rental income before depreciation.
Without a study. Residential rental property depreciates over 27.5 years, mid-month. The IRS table gives 27.5-year property placed in service in July a first-year rate of 1.667 percent. $350,000 times 1.667 percent equals $5,835. His rental result is $9,000 less $5,835, or $3,165 of net income. No loss, so the allowance has nothing to work with.
With a study. An in-house analyst reviews the house, through a live video walkthrough or a guided photo and video checklist the team reviews frame by frame on a property this size, along with the closing documents and any renovation records. On a single-family rental, appliances, removable carpet and vinyl, window treatments, and outside items like fencing, the driveway and landscaping are examined as 5-, 7- or 15-year property where the engineering supports it. Kitchen cabinets and countertops stay with the building. Say the study supports 22 percent, or $77,000. Ben acquired and placed the house in service after January 19, 2025, so under Section 168(k) as amended by the One Big Beautiful Bill Act, the full $77,000 takes 100 percent bonus in year one; bonus is not prorated.
The remaining $273,000 stays on 27.5 years: $273,000 times 1.667 percent equals $4,551. Total first-year depreciation is $81,551. His rental result is $9,000 of income less $81,551, a net rental loss of $72,551.
Now the allowance decides how much of that helps him this year. Ben is single, his MAGI is about $95,000 and he actively participates. Below $100,000 there is no phaseout, so he deducts $25,000 against his wages. At his 22 percent federal bracket, that is $5,500 of federal tax saved in year one. The other $47,551 suspends and carries forward.
| Ben's MAGI | Allowance | Loss used this year | Loss suspended | Federal tax saved this year |
|---|---|---|---|---|
| $95,000 | $25,000 | $25,000 | $47,551 | $5,500 at 22% |
| $135,000 | $7,500 | $7,500 | $65,051 | $1,800 at 24% |
| $155,000 | $0 | $0 | $72,551 | $0 this year |
At $135,000 the math is $25,000 less half of the $35,000 excess, which leaves $7,500. At $155,000 the allowance is gone. The tax figures are rough, since actual savings depend on the rest of the return, but the pattern holds: generous under $100,000, modest in the middle, zero above $150,000. That is why the question of whether a study will help has no one-word answer.
The unused loss becomes a suspended passive loss, tracked on Form 8582 and carried forward without limit. It comes back three ways:
A suspended loss has real value on a delay. Whether the delay is worth the fee depends on the holding period and on when passive income or a sale will absorb it.
Owners of Airbnb and VRBO properties often assume the $25,000 allowance covers them. For most it does not. Treasury Regulation 1.469-1T(e)(3) says an activity is not a rental activity if the average period of customer use is seven days or less, with the average weighted by gross rental income across classes of property. A related exception reaches average stays of 30 days or less with significant personal services. Fall into either and the property is a trade or business, and the question becomes material participation under Reg. 1.469-5T: more than 500 hours, or substantially all of the participation, or more than 100 hours and not less than any other individual, including your cleaner.
Materially participate and the activity is nonpassive: losses offset wages with no allowance and no income phaseout. Fail every test and the activity is a passive business, outside the rental definition, so the Section 469(i) allowance does not reach it either, and the loss waits for passive income. Mid-term rentals, such as furnished 30-day stays for traveling nurses, run the other way: average stays over seven days with no significant services make them rental activities, and the allowance may be available if you actively participate and your income is under the phaseout. Measure your average stay before you count on either rule.
Real estate professional status under Section 469(c)(7) has no income limit. You spend more than half of your working time and more than 750 hours in real property trades or businesses you materially participate in, spouses cannot combine hours to get there, and you still have to materially participate in the rental activity itself or make the aggregation election under Reg. 1.469-9(g) for the losses to be nonpassive. For a full-time W-2 employee like Ben it is out of reach. For a couple where one spouse works in real estate full time it can be realistic. Many owners use the allowance with their first rental or two and move to professional status if real estate becomes their main occupation.
If you bought your rental in a prior year without a study, a lookback study uses the same engineering on the house you already own, and the missed depreciation is claimed on the current return through Form 3115 and a Section 481(a) adjustment, with no amended returns. Cost Seg America prepares the Section 481(a) computation and, for a separate fee, the Form 3115 itself; your CPA files it. The catch-up lands at the bonus rate of the year the house was placed in service. The allowance and its phaseout are tested in the year you claim the catch-up, and a catch-up will almost always exceed $25,000, so most of it suspends. Model this year's MAGI and any passive income before filing; an unusually high or low year changes the right timing.
None of these should be adopted for the tax result alone. They are conversations for a CPA who knows your full picture.
Clearing the passive rules does not end the analysis. The deduction cannot exceed your tax basis or your at-risk amount under Section 465. Nonpassive business losses face the Section 461(l) cap, $313,000 single and $626,000 joint for tax years beginning in 2025 and $256,000 single and $512,000 joint for 2026, adjusted annually, with the excess carried forward as a net operating loss. The 3.8 percent net investment income tax touches rental income and gain. The study supplies the depreciation schedule; your CPA applies the limits.
On a $350,000 house the fee has to earn its keep, and an estimate that applies a percentage from a database is Approach 6 in the IRS Audit Techniques Guide, little or no documentation, which the guide tells examiners to view with caution. A fully engineered and accounted cost segregation study examines the house component by component under Approaches 1 and 2 of the guide, from actual cost records and documented estimates reconciled to the purchase price, and delivers a component schedule with each asset's cost, class and recovery period that your CPA imports and an examiner can trace line by line. Credentialed professionals sign it. Cost Seg America defends it for as long as you own the house, with no time limit, no hour cap and no additional fee, through written responses and participation in examiner calls alongside your CPA, and has done so in more than 125 IRS examinations with zero losses and $0 returned.
If your MAGI is above $150,000, you cannot qualify as a real estate professional, your stays are long-term, you have no passive income and you plan to hold for decades, the study's benefit is real but deferred: the suspended loss does nothing until a sale, a drop in income or passive income arrives, and the question is whether the present value of that deferred deduction beats the fee. On a house with less than $180,000 of depreciable basis after land, which is Cost Seg America's minimum, it does not. If you plan to sell within a couple of years, the Section 1245 recapture at ordinary rates arrives before the time value has done much. On the other side, if you are under $100,000, actively participate and own a house with meaningful personal property and land improvements, the first $25,000 is deductible now and the balance is stored. For many owners in Ben's position the study pays for itself on the first return. The free proposal says which case you are in.
Yes, as long as you still actively participate. Approving tenants, setting rent and approving major expenses count, even when the manager runs daily operations.
No. It is $25,000 per return on the combined net loss from every rental you actively participate in.
No. MAGI for this purpose is figured without passive losses, so the extra depreciation does not reduce the income being tested.
It suspends and carries forward without limit. It offsets future passive income, uses the allowance in a lower-income year, or releases when you sell your entire interest in a fully taxable sale to an unrelated party.
Usually not. With average stays of seven days or less, weighted by gross rental income, the activity is a trade or business rather than a rental activity, and the question becomes material participation.
It can. Average stays over seven days with no significant personal services make it a rental activity, and you qualify if you actively participate and your income is within the limits.
Yes. A lookback study with Form 3115 claims the missed depreciation on the current return with no amended returns, at the bonus rate of the year the house was placed in service. The allowance is tested in the current year.
No. A joint return gets one $25,000 allowance with the same $100,000 to $150,000 phaseout.
Ben kept his job and his twelve-month tenant. What he needed was the rule that applied to him, a reliable estimate of the first-year loss and a CPA who understood the phaseout. Send Jim Dougherty and his team the property address, the purchase price and the closing date, and you will have a free proposal in 24 hours showing the projected reclassification, the first-year deduction and the fee, with no obligation, to share with your CPA before you commit to anything. The study is delivered in 30 days, rush available. Our team has prepared and defended engineered studies since 2002. Call 1-888-365-5023 or write to info@costsegamerica.com.
This article is for educational purposes only and is not tax, legal or accounting advice; consult your CPA about your own situation.
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