Passive vs Active Real Estate Investing
Are you a passive or active real estate investor? This is a key question to ask for anyone involved in purchasing and/or leasing investment properties. Passive investing means just that, the management and oversight of the property is passed over to someone else for management. When a property management company is being hired to manage a property, find tenants, screen tenants, and collect rent checks, it is for the most part considered a passive investing strategy.
On the other hand, active real estate investing means the purchaser is actually actively involved in the management, tenant search, maintenance and rent collection. This method is generally more time consuming, but can have major tax advantage compared to passive investing.
Passive property investors can mainly deduct expenses such as mortgage interest, home insurance, maintenance repairs and depreciation against the earned income from their properties. On the other hand, active property investors can deduct similar expenses against their property income as well as other means of income. This means if the active investor has other income streams from other jobs or investments, the deductions from real estate are first taken against the real estate income, and then taken against any other income assuming there is still a deduction remaining.
There is a fine line between hiring a property management company to manage a property and still being considered an active investor. Most people do this by documenting any time spent preparing or maintaining the investment property by themselves, recording milage driven to the property for any services or repairs done or rent collection, and documenting any decisions made by you which were requested by the management company. By doing these simple things, you can still be partially considered an active investor, and reap some of the tax benefits. Be warned however that the deduction limit is only up to $25,000 total from all properties that can be used against other streams of income in this scenario. The deduction limit is much higher if you are truly considered an active investor where you manage your properties and spend the IRS required amount of time per year dealing with investment properties or real estate.
As you can see, active investing or hiring a management company and being involved to get partial active investing tax benefits is well worth the time. This is the case especially if multiple properties are considered resulting in large depreciation deductions each year.
Tax laws change yearly, please consult your tax expert for the latest details and changes to investment property and real estate tax scenarios and laws.