Longtime lurker, first post. Thanks to the BiggerPockets community for all the invaluable advice -- it's helped me personally and professionally for many years.
Here's my question: This year my wages at my non-real estate job increased to $190,000. I'm a single filer with no dependents and really no deductions besides the losses from my real estate business, which this year total $25,000, and my personal mortgage interest of $12,000.
My accountant tells me that, because my modified adjusted gross income is more than $150,000 or so, I can no longer deduct my business losses against my income. Furthermore, he also says I can no longer deduct my personal mortgage interest expense against my income.
To the high wage earners out there -- any advice on how to still get these deductions, or other ones? Thanks everyone.
Ok, Steven Hamilton II, take a break from doing taxes and chime in here.
Almost certain you're mistaken on this point. At least for now, who know about the future.
But he's right about the passive losses from rentals. You can't deduct those. You can carry forward the disallowed losses and offset the gains from the sale when you sell. A related point that's often glossed over on the sale is that there are two taxes that will apply. One is the often-cited capital gains tax. That's currently 15%, if held for over a year. The other deals with depreciation. As you hold the rental, you take (or should take) a deduction for deprecation. That decreases the basis (whether you take it or not.) So, when you sell, your gain is increased. That depreciation is called "unrecaptured depreciation" and is subject to a 25% (currently) tax.
The real tax benefit for rentals is that the income is wholly or partially sheltered from tax, because of the depreciation deduction. But the reality is that good rentals don't generate passive losses. They generate taxable income, even after depreciation. That's good. It means you're making money. This theoretical "passive loss offsetting other income" idea is often used to slap some lipstick on a pig rental.
Great question, I'd love to hear the responses too! Tim, I'm sort of in the same boat as you, except married with a child. I have no properties yet but will be looking to acquire my first this year.
Great question Tim. I'd be curious to hear some of the Tax guys responses like Steve H.
The one thing I can think of is that all these disallowed losses can be carried forward until at some point you CAN use them I think?
The other thing is you still will get some benefits b/c you always can still reduce your taxable income with paper deductions such as depreciation. But YEs the 25k passive loss limitation is phased out completely @ 150k.
NOt being able to deduct your personal Mortgage income against your income sounds questionable though, I don't know of any income limitation disallowing this? What was his reasoning behind it?
I remember reading the max you can deduct is a million dollars in interest but I don't think youa re asking this question....
Lets hear what the experts have to say....
C
Thanks for the response, Chris. With respect to the carry forward of losses, my accountant did mention that I could carry these losses forward indefinitely until such time my income was below the threshold. I might have misunderstand the personal mortgage interest deduction, I can followup with him depending on what I learn here.
Ok, Steven Hamilton II, take a break from doing taxes and chime in here.
Almost certain you're mistaken on this point. At least for now, who know about the future.
But he's right about the passive losses from rentals. You can't deduct those. You can carry forward the disallowed losses and offset the gains from the sale when you sell. A related point that's often glossed over on the sale is that there are two taxes that will apply. One is the often-cited capital gains tax. That's currently 15%, if held for over a year. The other deals with depreciation. As you hold the rental, you take (or should take) a deduction for deprecation. That decreases the basis (whether you take it or not.) So, when you sell, your gain is increased. That depreciation is called "unrecaptured depreciation" and is subject to a 25% (currently) tax.
The real tax benefit for rentals is that the income is wholly or partially sheltered from tax, because of the depreciation deduction. But the reality is that good rentals don't generate passive losses. They generate taxable income, even after depreciation. That's good. It means you're making money. This theoretical "passive loss offsetting other income" idea is often used to slap some lipstick on a pig rental.
Tim Smith, as everyone has already chimed in, your accountant is quite right about the passive loss...it's gone due to your AGI.
He MAY also be right about your mortgage interest. If you are subject to the Alternative Minimum Tax then your mortgage interest is not deductible. There's a flat deduction for folks that fall under the AMT.
Not only that, the Taxpayer Relief Act of 2013 reinstated the personal exemption phase out AND the limitation of itemized deductions. After reaching a certain income level both of these begin to phase out.
Jon Holdman,
Fighting being sick here. I DO NOT get sick, But this time I didn't take my magic stay healthy elixir because I wasn't home.
Tim Smith,
That is correct, your deduction for passive rental losses are lost. I recommend finding some properties that provide a taxable income.
Your personal mortgage interest should still be deductible provided it was used to acquire or substantially improve your property.
Those losses you cannot deduct are called "Passive activity losses"(PAL). They are deductiblein the year in which the property is sold.
Chris Masons,
That is interest on $1m in Principal.
Bill Walston,
AMT technically only eliminates non acquisition/improvement debt.
-Steven
Not if the IRS considers you a Real Estate Professional - then the sky is the limit! :D
Right out of TurboTax business: Why are my Losses Limited?
Rentals are considered passive activities for most owners. There are rules that apply to passive activities that limit the losses you can take on your tax return. Here are a few reasons why your losses may not be fully deductible:
* You do not actively manage your rental so losses are only allowed if there are profits from other passive activities.
* You do actively manage your rental so $25,000 in losses are allowed if your income is $100,000 or less.
* Your income is over $150,000. None of your real estate loss is allowed.
* Your income is over $100,000 and less then $150,000. Some of your loss is allowed and some of your loss is carried over to the future.
* You are filing Married Filing Separately (MFS) and you live with your spouse during the year. This reduces allowable losses to zero.
* You are filing Married Filing Separately (MFS) and you live apart from your spouse the entire year. Your allowable losses are reduced by 50% to $12,500
Again more from TurboTax Business:
REAL ESTATE PROFESSIONAL
You are considered to be a real estate professional (i.e., in a real property trade or business) if:
1) more than one-half of the personal services you provided during the year were performed in a real property trade or business in which you materially participated; AND
2) the number of hours in which you materially participated in this real property trade or business was more than 750 hours; AND
3) you must materially participate in each rental real estate activity unless you filed an election to group all rental real estate activities as one (and materially participate in that activity).
A "real property trade or business" means any real property development, redevelopment, construction, reconstruction, acquisition, conversion, or rental operation, management, leasing, or brokerage trade or business.
Personal services performed as an employee are not treated as being performed in a real property trade or business unless you are a more than 5% owner of the trade or business.
For joint return purposes, the eligibility requirements are considered met if either you or your spouse separately satisfy the requirements.
MATERIAL PARTICIPATION
You materially participated in the operation of this business activity during the year, if you meet ANY of the following tests:
1. You participated in the activity for more than 500 hours during the tax year.
2. You are the only person who substantially participates in the activity, including individuals who do not have an ownership in the activity.
3. You participated in the activity more than 100 hours during the year and no one else participates more than you do, including individuals who do not have an ownership in the activity.
4. The activity is a significant participation activity, and you participated for more than 100 hours in each of several activities, and the total for all these activities is in excess of 500 hours.
5. If any of the above situations applied to you in any 5 of the last 10 years, you are deemed to have materially participated this year. (In determining if you materially participated in tax years beginning before 1987, you materially participated only if you participated for more than 500 hours during the tax year.)
6. If you materially participate in a "personal service" activity (child care, consultant, real estate agent, etc.) for at least three years, you are a material participant for life.
7. Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the tax year (you must have participated for more than 100 hours during the year).
However, your participation in managing the activity does not count in determining whether you materially participated if anyone (other than you) received compensation for managing the activity or if anyone spent more hours during the tax year than you performing services in the management of the activity.
8. If you are a retired or disabled farmer, you are treated as materially participating if you materially participated in 5 of the 8 years preceding your retirement or disability.
9. If you are a surviving spouse of a farmer, you may also be treated as materially participating in the farm, if the real property used for farming meets the estate tax rules for special valuation of farm property passed from a qualifying decedent and the surviving spouse actively manages the farm. (If you think you might qualify under this rule, contact the IRS for an explanation of those estate tax rules.)
If married, you can include your spouse's participation towards the 500 and 100 hour tests.
The work you performed must have been done at the time you owned an interest in the activity and must have been the type that an owner would customarily do in that type of activity.
SIGNIFICANT PARTICIPATION
A significant participation activity is any trade or business in which you participated for more than 100 hours during the year and in which you did not materially participate under any of the other material participation tests.
Special Deductions for Real Estate Professionals
Real estate professionals are people involved in many aspects of the rental property business, including buying and selling, owning, renting and leasing, remodeling, constructing and managing the rental.
If you're an average taxpayer and you happen to own rental property, you can deduct losses on that property only up to a certain limit because your ownership is considered to be a passive activity. If your income is above $150,000, you can't deduct any losses at all, unless you sell the property.
Special Rules for Real Estate Professionals
However, since 1994, real estate professionals have been eligible to deduct all of their losses from rental real estate activities in which they materially participate. Material participation is determined by several rules; for example, you need to spend more than half your time involved in the business of managing your properties.
We'll walk you through determinng the amount you can deduct based on how you manage your properties.
Not if the IRS considers you a Real Estate Professional - then the sky is the limit! :D
There is no way you can pass the threshold to be a Real Estate Professional if you have a full time job. A full time job is 2080 hours a year, so you would need to spend at least 2081 hours doing real estate to be a RE Pro. My rough estimate is it takes 20 hours a year to manage a rental, if you're managing it yourself.
So how do you get around the 150K per year rule? My cpa seemed happy that my day job put me over 150k. She said "that's a good thing and don't worry, you'll get your deductibles when you sell". Needless to say I wasn't happy so much. I make too much per year obviously but can't quite the day job because I have to be able to pay my bills and 2 duplexes and 3 houses are not going to cash flow well enough to replace 150k income. So I'm curious to know what strategy I should be using since I can no longer take any tax deductions - it's just me and my husband.
Short answer? You can't. At least not under the current rules and regs.
Your CPA is correct. You WILL get your deductibles when you sell.
There isn't a strategy that will allow you to take deductions for real estate losses if income is in excess of $150K. What does your CPA say? She's more "in the know" about your current tax situation than are we.
Tax season looms near and again I'm probably going to have to pay. I switched to a consulting job and IBM has done a forced cut back on hours of 4 hrs per week but I don't think that will make this less painful and although I upped the amount taken out of my day job salary I will still end up having to pay. I wish I could talk my hubby into leaving his job. I would at least then no longer be getting punished for pursuing my dream. With the new Obama care tax I know I'll be screwed tax wise and may find that I'm better off paying the 1% penalty in the coming year. So ironic I can't afford to work the job I love and the job I think of as the mouse trap was built complete with a quicksand pit. Perhaps I need to look for very short contracts of 1 or 2 months at a time taking maybe 3 weeks off in between as a way to decrease the amount of money I make?
Not that bad of a problem to have in this day and age.
Are you a W2 employee or an independent contractor? If you run your own consulting business, a few bad business decisions can make 'extra money' go away.
Hire my IT firm as a subcontractor, pay us $20,000 to back up your PC. Poof! your problem is solved, I'll suffer the slings and arrows of higher taxes for you.
If you are W2, then the only way to avoid that 150k is to go ask for pay cut. I'm sure IBM would be thrilled to deal with higher income and the taxes that go with it.
For the most part, as long as taxes are not at 100%, you are better off making more. But I'm curious, and the tax guys can probably give examples, if you are at 155,000 and you have hit a phase out/rule that says you cannot deduct 25,000 in depreciation, isn't your effective tax rate on that last 5,000 over 100%?
In that case, as silly as it sounds, 'making less', even by giving it away somehow, leaves you 'ahead' at the end.
@Maria Hanson if you are a W2 employee getting paid that much, quit and become a contractor. As a self employed person, start a solo-401k - reduce your AGI by doing massive profit sharing contriubtions 25% of salary, plus deferring another 17,000 - you can knock 25,000 + 17,000 = 42,000 off a 100,000 salary that way.
I'm not an accountant, I'm pretty sure both of these reduce your MAGI, I'm more confident that the profit sharing contribution does so.
Do you do project work? contracting is very common.
Dave
I work for a consulting company (w2) that has me assigned to their client which is IBM who has me assigned to their client. I have an LLC (I'm a sole proprietor) which owns 4 properties (7 units total). When taxes are filed the CPA uses schedule E and both sources of income(IT job and rentals) plus my husbands income are used.
I guess I'm frustrated because I haven't found a good way to deal with the taxes. I don't mind paying taxes (we need good roads, need our country defended, need to take care of our vets who do the defending). Taxes are daunting to me because I know at the end of the year when the CPA files I'll have 6,000 to 9000 that I will have to shell out of my pocket for the bill (above what's taken out of my day job) and nothing can be written off for the LLC or even our own house.
I like your idea of becoming a self-employed contractor. I never thought of doing something like that. I think I'll do some research and see how viable it is in OH. Thanks Dave.
You are better off making the money and paying the tax on it. Increase your withholding further. Paying at the end of the year is good. It means you are making money. I hope both of you are maxing out your 401ks and IRAs.
@David C ,
No, the 25k special allowance decreased $0.50 for every dollar of income over 100k. So, no it is not. That is taxable income.
Maria,
Being an independent contractor isn't bad; however, your boss would have to give you a raise to account for their half of Social Security and Medicare. Then consider using an S-corp, giving yourself a smaller wage, decreasing your Social Security and Medicare outlay. Hire one or two of your kids to do minor work for the S-corp.
Only issue in OH is for state tax purposes you don't get to subtract your personal 401k contributions as they are taxed for state purposes.
Thanks for the great replies. I'm in the process of setting up some self directed IRA's. It looks like instead of Roth IRA's I should be going with traditional. I'll max them out for both me and my husband. I do have a question about charities. In the past we've given to DAV on a regular basis and the Hungarian church as well as a few others. What is the max that would be advantageous tax wise to give to charities?
Hello @Maria Hanson,
Very simplified, and subject to your own CPA's advice, you could deduct up to 50% of your adjusted gross income on your Line 22 of Form 1040 if the charity is a qualified 501(C)(3) nonprofit organization, such as a church, etc. But if you donate appreciated real property, you could deduct its full fair market value, as determined by an independent qualified appraiser, but only up to 30% of your adjusted gross income. However you can carry forward the unused deduction for up to 5 more years. Very definitely verify this with your own accountant before taking any such action.
Best wishes,
Jim
Tax advantage of donating to charity. There is none unless you are on the edge of a credit threshold. You donate $1,000 and receive a deduction of $280 if you are in the 28% bracket.
-Steven