Imagine a firefighter and a schoolteacher in their late twenties. They get married, purchase a modest two-family home, live in one unit, and rent out the other. On his days off, the firefighter makes improvements, while the teacher manages finances and paperwork. They've stretched themselves to the limit financially, but they feel good about owning their own home and building a foundation for future wealth through the rental.
When they file taxes for the first time, they're excited to get a big refund due to the massive rental expenses they incurred. Instead, they discover they can't deduct a single dollar of rental losses in the current year. Their CPA explains why: their income is too high. A firefighter and a teacher's salaries are considered too high to qualify for basic tax relief.
The 1986 PAL threshold: A quick refresher
When the passive activity loss threshold was introduced in 1986, its purpose was straightforward: Prevent the ultrawealthy from using passive real estate losses to sidestep taxes. Back then, a $150,000 income was roughly six times the median household income of $24,900, so it effectively targeted those at the very top.
Yet while other parts of the Tax Code — such as income brackets, the standard deduction and the Social Security wage base — are updated routinely, the PAL threshold has stayed frozen in time, actively punishing hardworking Americans. This is reminiscent of the alternative minimum tax problem — created to snare high earners, the AMT gradually caught many middle-income taxpayers as the cutoff failed to keep pace with inflation.
Why the threshold creates ripple effects that harm entire communities
Thanks to inflation, rising real estate prices and higher costs of living, many two-income families now exceed $150,000 without being anywhere near what could be considered "wealthy."
A household bringing in $150,000 might be juggling a mortgage, childcare expenses and a host of other financial commitments. They're not using real estate holdings for elaborate tax shelters; they're simply trying to build modest long-term security. Yet the outdated $150,000 limit means they can't deduct legitimate rental expenses now when they need them most.
The CPA perspective
Every CPA who handles real estate clients is familiar with the $150,000 PAL limitation. Part of our role is to warn clients just how quickly a teacher-and-firefighter household or two average professionals can lose these crucial tax benefits.
More importantly, CPAs are in a unique position to witness how this outdated threshold mislabels middle-income families as high earners. This mirrors the AMT scenario: Created for the top 1%, it started affecting everyone from young professionals to retirees on fixed incomes. CPAs across the country pushed for reform, and that collective voice led to change. Today, we face a similar challenge, and we need a similar push to bring the PAL threshold in line with modern reality.
Call to action
Every year this threshold remains unchanged, thousands more middle-class families lose their chance at building financial security. This isn't complex tax reform — it's a simple threshold adjustment that Congress could implement tomorrow. As CPAs, we have a unique perspective and a responsibility to act:
- Lobby for legislation: Urge your professional networks and organizations (like the American Institute of CPAs) to put this on lawmakers' radars.
- Educate clients and community: Use real-life examples, like our teacher-and-firefighter couple, to illustrate how the outdated threshold hurts ordinary families.
- Reference the AMT success: We've already solved this exact problem with the AMT fix, proving that thresholds can be updated when enough informed voices unite.
Returning to our firefighter and teacher, they aren't looking to game the system. They're an everyday household, committed to their community, hoping to create a small nest egg through a modest real estate investment. Yet the Tax Code treats them as if they're ultrawealthy, exposing a glaring disconnect between 1986's notion of "high income" and today's economic realities.
The solution is straightforward. Index the PAL threshold to inflation, or at least bring it up to a level consistent with modern income distributions. Doing so would align the rule with its original intent — preventing true tax abuses — while finally giving a fair shake to the middle-class families who were never meant to be targeted in the first place. Let's lead the charge and ensure this outdated law gets the overhaul it desperately needs.
