Education On Passing Through Tax Losses to Offset W-2 Income
Member since 2021 · 87 posts · 41 votes
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.
@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.
@William C., in short, yes. That is one of the beauties of real estate investing: the loss helps offset other income.
But...be clear on this...it is dumb to operate rentals at a loss purely to lower taxes. That is like paying someone $1 to avoid sending Uncle Sam a quarter. The only way this really works as a deliberate strategy is if your PAPER loss (i.e. depreciation) cancels out income in other areas.
Several of my properties show a loss after depreciation, which carries over to my AGI (Adjusted Gross Income) and reduces my overall tax liability on those earnings. But in fact, they are putting cash into my pocket each month.
You can still recoup a benefit from taking actual, cash losses on Real Estate if you have a bad year or a lot of repairs, or if it's the first or second year of ownership and the project hasn't become profitable yet due to expenditures on upgrades that increase the value of the property, but ultimately your goal with investing should be to make money, not lose it. However, if you take a loss, deducting that against other income helps soften the blow.
@William C., in short, yes. That is one of the beauties of real estate investing: the loss helps offset other income.
But...be clear on this...it is dumb to operate rentals at a loss purely to lower taxes. That is like paying someone $1 to avoid sending Uncle Sam a quarter. The only way this really works as a deliberate strategy is if your PAPER loss (i.e. depreciation) cancels out income in other areas.
Most of my properties show a loss after depreciation, which carries over to my AGI (Adjusted Gross Income) and reduces my overall tax liability on those earnings. But in fact, they are putting cash into my pocket each month.
You can still recoup a benefit from taking actual, cash losses on Real Estate if you have a bad year or a lot of repairs, or if it's the first or second year of ownership and the project hasn't become profitable yet due to expenditures on upgrades that increase the value of the property, but ultimately your goal with investing should be to make money, not lose it. However, if you take a loss, deducting that against other income helps soften the blow.
Thank you for the reply. More details: My properties do cash flow positively each month and my BiggerPockets education is to thank for that. Similar to you, my rental properties produce a paper loss after depreciation is factored in.
Is the carry over to reducing your AGI via paper losses on rental properties something that essentially takes care of itself when it comes to tax time? Allow me to explain further. Is any type of entity (ex. LLC) needed to insure that these losses carry over from the rental property side of things to offset income made from a typical W-2 job. How do you go about making sure the paper losses from your real estate work get carried over to offset the income you make from your normal job?
@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.
@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.
This is big time! The example is great. One of the many reasons why the BP community is top notch. Thank you for taking the time. My CPA is not an "expert" in the real estate niche and I often wonder if finding a CPA that specializes in RE would be worth it... I'm not sure if I am a big enough player to make it worth it just yet so I try to understand this stuff on my own.
That being said, we are fortunate in that our W-2 income is decent. We are above the $150,000 threshold, so using paper losses from our rentals to reduce our overall AGI is not something we are able to do. At least that is my understanding of our situation. Do you know anything about this $150k threshold and if I am interpreting this correctly?
@William C., The deduction against W-2 income starts to fall off above $100,000 and is completely eliminated at $150,000. You can still use it to reduce taxes on your rental income, and anything you can't use "this" year gets carried forward indefinitely into future years. So you can "bank" the loss to help shield rental income once your property is 100% depreciated.
That's my understanding anyway. I recommend hiring a CPA who has experience working with REIs.
I just visited with my CPA who is very good at REI and does such himself. He explained that above the $150,000 threshold the loss becomes a "suspended loss". By not claiming these losses then I don't have to account for how many hours I work at REI. In other words I don't have to prove that I can have a high income job and work alot of hours and still have the time to run my rental business. These suspended losses will accumulate and then when I would like to sell some real estate that has equity, I will be able to use these suspended losses against the equity and essentially pay that much less in capital gains. Wonderful news, as I don't need the money back in taxes now but sure will enjoy later in retirement when I contemplate selling for profit.
And spend the extra money for a great CPA with REI experience. The first year we lost a significant amount of money for equipment that was not included in depreciation, as our CPA was not familiar with it.
And spend the extra money for a great CPA with REI experience. The first year we lost a significant amount of money for equipment that was not included in depreciation, as our CPA was not familiar with it.
@William C., The deduction against W-2 income starts to fall off above $100,000 and is completely eliminated at $150,000. You can still use it to reduce taxes on your rental income, and anything you can't use "this" year gets carried forward indefinitely into future years. So you can "bank" the loss to help shield rental income once your property is 100% depreciated.
That's my understanding anyway. I recommend hiring a CPA who has experience working with REIs.
Thank you for this. Very helpful. And yes on the CPA with a REI focus. Starting that interview process now!
I just visited with my CPA who is very good at REI and does such himself. He explained that above the $150,000 threshold the loss becomes a "suspended loss". By not claiming these losses then I don't have to account for how many hours I work at REI. In other words I don't have to prove that I can have a high income job and work alot of hours and still have the time to run my rental business. These suspended losses will accumulate and then when I would like to sell some real estate that has equity, I will be able to use these suspended losses against the equity and essentially pay that much less in capital gains. Wonderful news, as I don't need the money back in taxes now but sure will enjoy later in retirement when I contemplate selling for profit.
Yes, thank you!