offset rental income with rental loss ?

Question

trying to find the answer but cannot find anything useful....

* I have a rental property that produces 7k rental income/yr.

* I want buy a (vacation) rental property that will produce 9k of rental loss/yr.

* our MAGI exceeds 150k.

* We are materially / actively participating in both properties, but we are not RE professionals.

The question is - can we offset the 7k of rental income that we currently pay taxes on with the 9k rental loss so that we pay $0income tax between the two properties, and carry forward the 2k (a year) loss until the day we sell vacation rental property?

Or - do we have to pay the income tax on 7k rental income without ability to deduct a penny from the 9k rental loss (due to MAGI>150k) ?

Thank you in advance!

Dave Toelkes · Answer

@George P.

I do believe I understand your question, although I am thoroughly confused by some of the responses you have received.

As I interpret the tax code, passive losses are offset by passive income regardless of your level of active participation, or total income.  If you have netted your income and losses and end up with a net positive passive income, then the net is taxable as ordinary income.  If the net is a taxable loss, the loss is carried forward to offset future passive income, or, until your interest in the passive activity is sold.  Net and suspended passive losses can be used to offset other ordinary income in the year 100% of your interest in the passive income activity is sold.

Only when the passive activity is residential rental property, are you allowed to use up to $25K in net passive losses from a residential rental activity to offset your other ordinary income under certain conditions.  These conditions include:

• At least 5% owner, and,
• Active participant, and,
• Less than $150K MAGI

If you do not meet all three of these conditions, then some or all of your net passive losses are suspended and carried forward to next year to offset rental income  Additionally, any loss in excess of whatever net passive loss deduction you are allowed to take is also suspended and carried forward to the next tax year.  All of your suspended passive losses for the property can be used in full to offset other ordinary income in the year the property is sold, regardless of your income and without regard to the $25K cap on the net passive loss allowance.

Brandon Hall · Answer

@Brian Moseley perhaps he was referencing the requirements to qualify as a real estate professional. To actively participate in your rental activity you must simply make management decisions, which most landlords do.

Passive losses can offset passive income. The nature of the loss does not matter.

There are three levels of participation in regards to rentals.

The first is an "investor." Think of this as owning a share in a syndication or being a money partner. An investor is very limited in what he/she can write off.

The second level is "active participation" which most landlords qualify as. At the most basic level, if you are making management decisions, you qualify as actively participating. If you have passive losses in excess of passive income, you can write off up to $25,000 assuming your AGI is below $100k. Between $100k and $150k, the $25k limit is phased out. Above $150k, you cannot write off passive losses.

Note - this is in regards to passive losses in excess of passive income. If you do not have passive losses, these rules won't necessarily apply.

The third level is the "real estate professional" which I've written about many times on these forums. It requires 750 hours and more than half your time of participation in a real estate trade or business. Qualify for this and you can write off an unlimited amount of passive losses.

Petra M. · Answer

Passive losses can be applied against passive gains.  So, yes you can take your $9k loss against your $7k income.  You can't apply your $2k loss against your W2 income (active) unless your a real estate professional.

Pam Storm · Answer

I'm going to concur w the posts above...i think you could offset as long as you are active.  We have a  vacation rental that we actively manage that has had some losses that do at times offset rental income from other properties...but there are so many factors that play in.  Many of your losses can get maxed out depending on how high your AGI becomes etc.  Lots of tax changes lately, consult your CPA for sure.

Mike H. · Answer

Ultimately, I think thats always going to be key. You have to have an active participation in the rental - whether its a vacation rental or not - in order to deduct the losses. For that you really want to contact a CPA and see what kind of effort they believe that entails.

For some people, they manage the vacation rentals themselves from a distance. They put up the listings. They speak with the people looking to rent the house (I'm assuming you're talking about some sort of airbnb type of vacation rental.  But I think condos sometimes let you do that and they manage everything for you. So I guess that might be a deal breaker.

But if you're managing both properties in some form or fashion (screening applicants, managing the cleaning people, handyman, etc), then I believe you would be able to use the vacation rental loss from other rental profits.

Its really one that you have to get your cpa to make the ruling on though. Too many gray areas.

And maybe ask if it matters whether you put the vacation rental under a corporation as opposed to having it under your name.

Frank B. · Answer

Not to derail the discussion, but have you considered that you might actually make more money just paying the taxes on your 7k?

If you have $9k loss, you may actually be losing money. Im sure you already did the math but just thought I'd throw this out there.

Brian Moseley · Answer

@Brandon Hall Right! Thanks for the clarification!

Brian Moseley · Answer

I use a CPA who does the taxes for a large number of real estate investors and owns investment properties. He says that one can only be considered active and use those losses if the majority of one's income is from the investment properties (not a job) and a certain amount of hours are spent operating the business. Otherwise, it would have to be considered passive income.

George P. · Answer

Thank you.

Schedule E allows entering up to three properties (A,B,C) and on the bottom are the sums for all the properties. So yes, assuming active participation req's are met, the passive loss on one property will offset the passive income of the other.

Regarding business income/vacation rental comment.. I looked into it - it'd be applicable if I did the room cleaning, provided maid services etc. (my understanding of it, anyway).

Thank you everybody!

offset rental income with rental loss ?

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