Do expenses on long term rental reduce earned income

[Carlson Driver]

I have a long term rental in a duplex (one of which is already rented) that we are just putting on the market. 

We have spent say about $10K of money to rehab the property before renting it out. 

Assuming that our taxable earned income is $100K from the day-job, will the $10K spent in rehab reduce our taxable income to $90K?

[Jim Kennedy]

Definitely sometimes, but it really depends on the rest of your income. Here's the deal:

-Internal Revenue section 61 says that unless specifically excluded  ALL income is taxable.

-Section 162 gives you a break, though and says you can deduct all necessary and ordinary expenses incurred in earning that income. The gain or loss is ordinary income and can offset other ordinary income, like your day job W-2, interest income, unemployment received and a whole host of other items that reduce your ordinary income. 

-This is important because  long term capital gain rates are more favorable then the hideous incremental rate at which you are being taxed but you need all the help you can get in lowering your ordinary income, and rentals are just the way to do that, featuring depreciation-driven losses. So yes they can offset income. BUT - not always

-If your modified adjusted gross income (basically usually your total gross income plus or minus some things that you don't see very often) is below $100K, you can use up to $25,000 of rental losses to offset other ordinary income, like your W-2 wages, etc. The excess are suspended (see below for what that means)

-When you have a day job, and do real estate on the side, and your modified  adjusted gross income income hits $100,000, the IRS says "Congratulations, you're rich! And because you're rich, you don't need these losses as much as some person struggling with less than that in income." Therefore, as you go from $100K to $150K, the allowable portion phases out. At $150K your allowable loss is ZERO.

-Its not all bad news, though. Your losses aren't lost forever. They wait somewhere (and are tracked cumulatively on Form 8582) until either 1) your income drops below the $150K threshold and they start to phase back in, or 2) you sell the unit, and then they ALL kick in.

-If you are a bona fide real estate professional under Internal Revenue Code section 469 et seq, then these loss limitation rules don't apply, and your losses are fully deductible in the year in which they occur.

Hope that helps. Happy investing!

Jim Kennedy