Real Estate & Rental Property
If you own rental property and your CPA has told you a loss is "suspended" rather than deductible, you've run into the passive activity loss rules — one of the most misunderstood parts of the tax code for Maryland landlords.
Here's a scenario we see constantly: a landlord earns a solid salary at their day job, owns a rental property that shows a loss on paper after mortgage interest, repairs, and depreciation, and assumes that loss will offset their other income. Then tax season arrives and the loss doesn't show up the way they expected. Nothing was done wrong — this is simply how the federal passive activity loss rules work, and most landlords have never had them explained clearly.
If you're a landlord or rental property owner anywhere in Frederick County or central Maryland, understanding these rules is one of the highest-value things you can do for your tax bill. Here's what's actually going on, and the three main ways to work within — or around — the limitation.
Under Section 469 of the tax code, rental real estate is automatically classified as a passive activity, regardless of how involved you personally are in managing it. This matters because passive losses can generally only offset passive income — not your W-2 wages, not your business income, and not your portfolio income like dividends or interest.
So if your rental shows a $15,000 loss for the year and you don't have other passive income to absorb it, that loss doesn't disappear — it gets suspended and carried forward to future years, waiting until you either generate passive income or qualify for one of two key exceptions.
"My CPA told me my rental loss was suspended" is one of the most common things we hear from new landlord clients. It's not a mistake — it's the law working as designed. The real question is whether you qualify for an exception that changes the outcome.
If you actively participate in managing your rental — meaning you make real decisions like approving tenants, setting rent, and authorizing repairs, even if you use a property manager for day-to-day work — you may be able to deduct up to $25,000 of rental losses against your other income each year.
The catch is an income phase-out. This allowance starts shrinking once your modified adjusted gross income passes $100,000, and disappears entirely at $150,000. For many Frederick County landlords who also hold a well-paying job, this phase-out is the single biggest reason their rental losses end up suspended rather than deductible in the current year.
| Your MAGI | Active Participation Allowance |
|---|---|
| $100,000 or less | Up to $25,000 |
| $120,000 | Roughly $15,000 |
| $135,000 | Roughly $7,500 |
| $150,000 or more | $0 |
If your income already puts you near or above this range, the active participation allowance may offer little or no help — which is exactly when the second exception becomes worth a serious look.
To use this allowance at all, you need to own at least 10% of the property and be taxed as an individual, not through a corporation. Married couples who file separately while living together generally cannot use any portion of this deduction at all — a detail that surprises a lot of joint filers when they consider filing separately for other reasons.
This is the more powerful — and more demanding — exception. If you qualify as a real estate professional, your rental activities are reclassified as non-passive entirely, which means your losses can offset your W-2 wages, business income, or any other income source without the $25,000 cap or the income phase-out.
To qualify, you generally need to meet two separate tests in the same tax year:
The first test is where most W-2 employees get tripped up. If you work a full-time job unrelated to real estate, it's very difficult to also claim that more than half your total working time went toward managing rental property — and the IRS and tax courts have scrutinized this claim closely in audits. This is often where a spouse who isn't otherwise employed, and who genuinely manages the rental portfolio, can qualify instead, since only one spouse needs to meet the test on a joint return.
Real estate professional status isn't something to claim casually. The IRS has successfully challenged this status in many audits where the taxpayer didn't keep contemporaneous records — time logs, calendars, and documentation showing exactly when and how those hours were spent.
Even landlords who never qualify for either exception aren't out of luck forever. When you sell your entire interest in a rental property in a fully taxable sale to an unrelated buyer, all of the suspended losses tied to that property become deductible in the year of sale — against the gain on the sale itself, and then against any other income if losses exceed the gain.
This is one of the most overlooked planning opportunities for landlords who've accumulated years of suspended losses. Timing a sale to coincide with a high-income year, rather than simply selling whenever the market looks good, can meaningfully change how much of that suspended loss actually saves you in tax.
One important detail: selling only part of your interest, or selling to a related party such as a spouse or a controlled entity, generally doesn't trigger this release. The sale needs to be a complete, arm's-length disposition.
None of these exceptions matter if your records can't support them. Whether you're trying to substantiate active participation, real estate professional hours, or simply tracking depreciation correctly across multiple properties, clean books are the foundation everything else depends on.
If you're managing more than one rental property, this is also where entity structure decisions come into play — whether to hold properties individually, through an LLC, or grouped together for tax purposes can affect how depreciation, losses, and eventual sales are treated.
At Mercer Flanagan, we work with landlords across Frederick County and central Maryland to determine which of these exceptions actually applies to your situation, set up bookkeeping that supports it, and plan sale timing around your suspended losses rather than letting it happen by accident. We've been doing this since 1971, and we know the difference between a paper loss and a usable deduction.
Whether you own one rental property or a growing portfolio, we offer:
Book a free consultation and we'll walk through your specific situation — no pressure, no obligation.
Book a Free ConsultationBy Roy Cogliandolo, CPA · Mercer Flanagan · February 28, 2026
This article is for general informational purposes and reflects tax rules current as of 2026. Individual circumstances vary — speak with a CPA before making decisions based on this information.