Monday, December 11, 2017

Treatment of REAL ESTATE LOSSES under 1040


Renting a residential property is considered "passive activity", which means it is a side-business that doesn't require paying self-employment taxes.

If your rental property has generated losses in past years, you might have suspended passive activity losses (PALs). You can generally deduct these losses only against passive income, which can be from other activities such as rentals or other passive business activities.

Losses from selling a personal residence are not deductible. You can only claim tax losses for sales of property used for business or investment purposes. 

Passive losses from activities in which you did not materially participate usually cannot be deducted from non passive income — active (earned from work) or portfolio income, but there is an exception for rental income, where up to $25,000 of rental losses can be deducted against active or portfolio income. The $25,000 deduction is phased out when your modified adjusted gross income is from $100,000 to $150,000, resulting in no deduction above $150,000 (for a married filing joint return).
Example. Kate, a single taxpayer, has $70,000 in wages, $15,000 income from a limited partnership, a $26,000 loss from rental real estate activities in which she actively participated, and isn’t subject to the modified adjusted gross income phase out rule. She can use $15,000 of her $26,000 loss to offset her $15,000 passive income from the partnership. She actively participated in her rental real estate activities, so she can use the remaining $11,000 rental real estate loss to offset $11,000 of her non passive income (wages).

Basically, a Passive Activity Loss is any loss coming from any rental activity such as the rental of investment property. Rental investment property is reported on Schedule E, Page 1 of Form 1040. To determine if you have a loss that may be limited, you need to compute the property’s total income and expenses. Expenses always include depreciation, even if it increases an existing loss.
There Are Two Kinds of Passive Activities:

Rentals, including both equipment and rental real estate, regardless of the level of participation.
Businesses in which the taxpayer does not materially participate on a regular, continuous, and substantial basis.

Real Estate Carry forward

A disallowed loss is suspended and carried forward as a deduction from any passive activity in the next succeeding tax year. Any unused suspended losses are allowed in full when the taxpayer disposes of his entire interest in the activity in a fully taxable transaction.
Losses that are not deductible for a particular tax year because there is insufficient passive activity income to offset them (suspended losses) are carried forward indefinitely and are allowed as deductions against passive income in subsequent years.
Rental property passive losses that are not deductible right away are called suspended passive losses. These deductions are not lost forever. Rather, they are carried forward indefinitely until either of two things happens:

you have rental income (or other passive income) you can deduct them against, or
You dispose of your entire interest in the property.
An exception exists for individuals who actively manage their own rental property and have modified adjusted gross income, or MAGI, below a certain threshold. The maximum loss an individual can claim from actively managed rental activities is $25,000. The $25,000 cap is reduced by $1 for every $2 dollars that MAGI exceed $100,000. If an individual’s MAGI is $150,000, they cannot claim any passive loss.

If for example, you have $12,000 in rental income, $15,000 in rental expenses such as broker’s rental commissions, condo fees, interest and taxes, and $3,000 in depreciation, your overall loss is $6,000. The $6,000 would be fully deductible if your MAGI are under $138,000. In other words, your MAGI is over the lower limit by $38,000. This excess is divided by $2 to arrive at a $19,000 reduction to the $25,000 overall loss cap, leaving up to $6,000 in deductible loss. If your MAGI is $140,000, your maximum deduction is $5,000 and the remaining excess of $1,000 is not currently deductible but rather carried forward to future years.

The $1,000 carry forward is not distinguished as any particular expense for the year. It is labeled passive activity loss carry forward and can be offset by any passive activity loss income in future years, including income from another activity. It can also be claimed as part of the $25,000 allowance in subsequent years. For example, suppose in the next year you have the same $6,000 rental loss. Your total loss including your carry forward would then be $7,000. If your MAGI in that year is under $136,000, you can claim the full $7,000 as a deduction in that year.