Filing separately has many tax ramifications, most of them bad. One of the less well-known is the impact married filing separately status has on the ability to deduct rental losses, whether by qualifying as a real estate professional or by utilizing the $25,000 rental loss offset available to all landlords with incomes below certain levels. If you need such to deduct rental losses, think twice about filing separately.

This is what Julie A. Oderio found out. She owned a rental property that incurred a $29,583 loss in 2008. For reasons that are unclear, she and her husband Jason filed separate tax returns for that year. The IRS later audited Julie and denied her 2008 rental loss.

Example: Julie claimed that she was entitled to deduct the loss because she qualified as a real estate professional. Unlike everybody else, real estate professionals are allowed an unlimited annual deduction for rental losses. However, to qualify as a real estate pro a landlord must:
– spend more than half (at least 51 percent) of his or her total working hours during the year working in one or more real property businesses;
– spend more than 751 hours a year in one or more real property businesses;
– and materially participate in the rental activity and any other real property businesses used to pass the 51 percent and 751-hour tests.

Julie admitted that she did not meet the 51 percent or 751-hour tests to qualify as a real estate pro. Although she worked full time for a real estate investment company, she was an employee who failed the ownership test, so this time did not count. If you are an employee in someone else’s real property business, your time counts toward real estate professional status only if you own more than 5 percent of the business. If you work as an employee for a corporation, you must own more than 5 percent of your employer’s outstanding stock.
However, Julie argued that her spouse Jason did meet the 51 percent and 751-hour tests and therefore she satisfied them too because his efforts were attributable to her. This can be true, but only if spouses file a joint return. In this event, the 51 percent and 751-hour tests are satisfied if either spouse meets them — but one spouse must satisfy both. For the third material participation test, both spouses’ time together is counted regardless of whether they file a joint return.

But there is no attribution of one spouse’s time working in real estate to the other if they each file separate tax returns. This means that a married taxpayer who files a separate return must separately satisfy the 51 percent and 751-hour tests. As a result, Julie could not deduct her $29,583 rental loss on the grounds that she was a real estate professional. Had she filed jointly, she could have so qualified and taken this deduction.
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AS: You can deduct mortgage insurance premiums [or PMI] if you were required to get PMI as a condition of receiving financing on your home. Some people will overlook that, although it’s typically disclosed on the 1099 that you receive from the bank, along with all the deductible information you need. The PMI deduction has been extended through 2013 and is retroactive for 2012.

[Another area of tax-filing confusion is] whether you’ve correctly treated any points you paid if you refinanced. In a new home purchase, the points can be deducted [in the tax year you paid them]. But typically in a refinancing, you have to amortize and deduct any points you paid over the life of the mortgage, and people tend to forget that after a couple of years. (Houselogic)

Landlords who don’t qualify as real estate professionals may deduct up to $25,000 in rental losses each year if their modified adjusted gross income is below $100,000.”