Depreciation/rental loss and taxes question

[Zach Z.]

Hello, 

New to property rentals and wanted to figure out the finances as clearly as possible before embarking on this. My situation is that my rental  income will be less than expenses (mortgage, insurance, property taxes, maintenance, management, etc.) I plan to depreciate the house for the tax benefits but I'm not sure there will be much benefit. Although from google, it seems the depreciation recapture tax will still apply when selling even if you don't claim it? It also seems like I would not be able to carry rental losses forward due to high income. Even if I were able to carry losses forward, it can only be used to offset rental income, not ordinary income. Any advice or insight would be greatly appreciated. 

[Linda Weygant]

Quote from @Zach Z.:

Hello, 

New to property rentals and wanted to figure out the finances as clearly as possible before embarking on this. My situation is that my rental  income will be less than expenses (mortgage, insurance, property taxes, maintenance, management, etc.) I plan to depreciate the house for the tax benefits but I'm not sure there will be much benefit. Although from google, it seems the depreciation recapture tax will still apply when selling even if you don't claim it? It also seems like I would not be able to carry rental losses forward due to high income. Even if I were able to carry losses forward, it can only be used to offset rental income, not ordinary income. Any advice or insight would be greatly appreciated. 

 Let me see if I can clear up a few things for you.

First, you indicate that your expenses will be less than your income and you include "mortgage" as an expense. Just to be clear, the only part of the mortgage payment that's deductible is the interest and PMI (if any). The principal amount is not deductible.

Second, you absolutely should deduct the depreciation because there is (or will be) benefit.

If your income is too high to deduct your passive losses, the benefits of owning a rental property are not lost.  The benefits simply carry forward into future years to be utilized later.  You can use them if/when one of three things happen:

1.  Your income dips below $150,000 in a year.  When this happens, prior and current year losses can be utilized in the normally calculated way.

2.  You have a future year with a rental profit.  This will happen as your interest expense decreases each year and your rental income increases.  When you have a year with a profit, any prior year losses will be deducted against that, bringing those profits down to $0.  This effectively creates tax free income in future years.

3.  You sell the property that is generating the loss.  In the year of sale, you can deduct all associated prior year losses without limit.

Remember - real estate is a get rich slow strategy.  Even if you don't get benefit today, the benefits will come into play in the future.

Best of luck to you.