Education On Passing Through Tax Losses to Offset W-2 Income

[William C.]

I understand this has the potential to be a complex discussion and consulting with my CPA will ultimately be the thing to do, but I am very curious what other's are doing in this space, thus coming the forum. After reading much of Amanda Han's work, tax strategies are top of mind for me. I have a normal W-2 income, but I own/manage rental properties as another stream of income. In a typical year, after factoring in depreciation and other expenses, we run at a net loss for the year. My question is: Are there mechanisms for passing-through the losses from the rental properties to offset the taxable income gained through my normal W-2 job? I understand there may be some questions that follow and I will be ready to answer them! Thank you for taking the time to read my post, take it at face value, and offer any experience you may have. Looking forward to seeing where this will go.

[Erik W.]

@William C., I don't know how you file your taxes, but if you do them anything like mine you have at least two sections.  One is the standard 1040 form for W-2 wages.  Line 1 is wages, salaries, and tips. Line 3b is qualified dividends. Line 8 is Other Income, which includes your rentals.  The other section is the Schedule E for rentals that show rents less expenses less depreciation = gain or loss.  This carries over onto your 1040 and is used to raise or lower your total income, and the result of that calculation plus whatever other credits or perks you qualify for via the tax code is your AGI.

Let's pretend you have a job making $100K a year.  Normally, you would owe taxes on that amount.  But....

Let's also pretend you have a rental that shows a paper loss of $10,000.  

Line 1 ($100,000) + Line 8 (-$10,000) = $90,000 AGI.  You would owe taxes on that amount.  $10,000 from your W-2 job effectively becomes ineligible for taxation.

The same is true if you take a loss on other types of incomes.  Let's say you bought stock for $100,000 and sold it during the Covid-19 slump for a $10,000 loss.  You can use that investment loss to reduce your W-2 wages from $100,000 to $90,000, but only if you actually sold the stock for less than what you paid for it.  If you hang onto the stock, that is only a paper loss and doesn't count.

Again, real estate is beautiful: we get to take paper losses caused by depreciation without selling the asset, while ironically the value of the asset is probably going up each year instead of down.