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Updated over 4 years ago, 08/03/2020
$25k Passive Loss to Offset Ordinary Income
Hello. My adjusted gross income is under $100,000, and so the passive loss (including phantom loss from depreciation, deductions from mortgage interest and property tax, etc.) from my rental properties will be offsetting my ordinary income by a maximum of $25,000 each year. Any offset above the $25,000 each year is carried over to the following year.
Since I plan on keeping those rental properties, I anticipate to be maxing out the $25,000 of offset each year. In this case does it even make sense for me to acquire more rental properties in the future? Passive loss coming from any additional rental properties will not provide additional tax benefits, since I will already be maxing out the $25,000 of offset each year. Am I thinking about this correctly?
If your losing 25k a year on paper then you are doing something very wrong. Most landlords have a small gain or a small lose after deductions, having rentals just for tax purposes is not why 99% of us own them.
@Samantha Klein The rental properties were acquired last year so the closing costs and stabilization were what contributed to maxing out the $25k. If I plan on acquiring additional properties in the future, there will once again be closing costs and stabilization associated and might max out the $25k again. That was where my question was coming from.
You made it sound like you were taking the full 25k offset every single year of ownership. Purchasing more depends on your goals.
You are probably well versed in that topic and fell free to ignore my post outright, but if not, please read up on which expenses at acquisition and stabilization can actually be deducted from income and which ones need to be amortized. I was disappointed as to how few can be deducted when I dealt with that topic for the first time.
@Manson C. If you were losing 25K each year you definitely are doing something wrong. If you had more than $25k in losses you could carry it forward to a year that you can use it so you don't lose it all.
I think you need to get some advice on your tax situation because you are making some errors in your assumptions.
First you must determine if your RE income is passive or active income. Unless you are a full time RE professional it is likely a passive activity for you. Passive losses are capped to $3
K as an offset against your ordinary income. Any additional loss will carry forward to the next year and offset of gains or keep accumulating as a loss carry forward.
I would also look at what you are calculating as a loss. Vacancy? That doesn't count, only real expenses.
Secondly, you seem preoccupied with losses and how they affect your income. Focus more on making money and worry about taxes second.
Get professional advise.
@William Jenkins I am not a RE professional, but I do actively participate in my RE activities so I do qualify for the $25k allowance. The loss that I refer to are all real expenses (except depreciation which is a paper loss) so no I didn't count vacancy.
Yes of course my main goal is to make money, but I do want to realize the tax benefits that real estate investing offers. I do agree with you that I need to get professional advice though.
Check out the IRS definitions of active participant. You can actively participate in the business (buy, sell, manage,etc.) and still have it qualify as a passive activity.
FYI.... Unless you are in a rare situation you likely want this to qualify as a passive activity. Next year you will likely have a gain even after factoring in depreciation. If it is active then you will be paying 15% self employment tax and ordinary income tax rates after that.
@William Jenkins just wanted to correct a few things here.
First off, rental property is passive and generates passive income as long as the rental period is greater than 30 days on average. Even if qualifying as an RE pro, it's still passive income and thus not subject to SE taxes.
You actively participate in a rental activity if you make management decisions. This does not make the income "ordinary income" it just means you actively participated.
The only time you are literally a passive investor is when you invest in a syndication or some group investment where you have little-to-no say and you don't make management decisions.
If you manage your own rentals, or manage the property manage who manages your rentals, you are deemed to be actively participating in your rental activity. Your rental activity will generate passive income or losses but you are still actively participating.
If a passive loss is generated, you have a $25k cap on the passive losses that can be applied against your ordinary income. There is no $3k loss limitation - this limit is on capital losses generated by portfolio (not passive) holdings.
Hope this helps clear things up.
@Brandon Hall Thank you. That's what I heard from the podcast.
I should have stated this earlier but the passive vs active classification I was referring too was at the LLC level where K1s are issued. Changes the game a little bit.
Several great suggestions posted here.
Main thing I would suggest, find a "Real Estate" CPA. Not a regular CPA, find a CPA who knows/owns property!
Your loses seem high, but we are looking in from the outside.
@William Jenkins this doesn't apply at the entity level:
"Unless you are a full time RE professional it is likely a passive activity for you. Passive losses are capped to $3K as an offset against your ordinary income."
A rental property is always going to generate passive income even if you are full time managing your portfolio. Passive losses are not capped at $3k.
There are three types of income: ordinary, portfolio, and passive. Passive losses are capped at $25k. Portfolio losses can be subject to the $3k limitation you referenced.
In my opinion, if you're NOT taking the $25k passive loss against your regular income then something is wrong. Using depreciation to defer taxes is one of the 3 key ways that rental property benefit me and my clients.
Reviving a dead thread here ....
My wife stays at home with the kids and does all the property management for our properties. Both of the buildings were bought in the last 5 months so we have a good amount of losses associated with the major repairs that they both required. These "losses" add up in excess of 25k but my AGI from my W2 income is above the 150k cutoff level.
Would she be able to qualify as a RE professional since all her professional time is spent managing these buildings? This way we could still write off the 25k since my income is above the cut off.
And does the 150k AGI level apply to married couples filing jointly?
@Nick N. Did you ever get a response to your question ? I’m in a similar boat and would like to know the same thing !
@Elizabeth Saienni
Yes, I actually did end up doing this. I got a new accountant who knows a lot about real estate tax implications.
He suggested we do it before I had a chance to ask him about it.
So far so good...
Nice! You took the right approach there.
Originally posted by @Nick N.:
@Elizabeth Saienni
Yes, I actually did end up doing this. I got a new accountant who knows a lot about real estate tax implications.
He suggested we do it before I had a chance to ask him about it.
So far so good...