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Ask Millionacres: How Do I Write Off Rental Losses?

[Updated: Jun 23, 2020] Feb 05, 2020 by Matt Frankel, CFP
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Q: In your recent article on rental property, you stated, "Taxpayers with MAGI above $150,000 cannot deduct rental losses, even as an active participant, unless they are real estate professionals." My question is, what if any strategy is there for a taxpayer in this situation to write off losses? For example, does forming a corporation such as S provide a route to using these losses? --John

A: Just to quickly recap for those who aren't familiar with the rules, if your rental properties show a loss for tax purposes, there are three groups of people in the eyes of the IRS when it comes to deducting those losses:

  • If you are a passive investor, meaning that you don't make management decisions or approve expenses for your rental properties, you cannot deduct net rental income losses against any other type of income.
  • If you are an active participant in your rental properties, you can deduct as much as $25,000 in rental real estate losses, but this begins to phase out if your modified AGI (MAGI) is greater than $100,000, and you cannot deduct any losses if your MAGI is above $150,000.
  • If you are a real estate professional, you can deduct any amount of rental losses, regardless of your income.

This means that if real estate isn't your primary occupation and you have more than $150,000 in MAGI, you can't deduct rental losses. And to answer one of your questions, if you form an S-corporation or similar entity that passes income and losses to its shareholders, the same rules apply.

So, if your MAGI is greater than $150,000 and you had rental property losses, you're probably out of luck -- for now.

However, it's important to realize that if you cannot deduct your rental losses, that doesn't mean they are lost forever. It simply means that you can't deduct these losses in the current year. You can carry the losses forward to future tax years and use them as soon as one of the following situations occurs:

  • You have positive rental income for a tax year. You can use an unused rental loss deduction to offset future rental income. For example, if you had a $2,000 loss in 2019 and your rental property produces a $3,000 taxable gain in 2020, you can use the unclaimed 2019 loss to reduce it.
  • Your income (MAGI) falls below the $150,000 threshold. If this is the case, and you're an "active participant" in your properties, you can deduct unclaimed losses to the extent your income allows.
  • You sell the property. You can deduct any unclaimed passive losses if you dispose of the property, as long as it's your only rental property or you treat it separately for tax purposes.

As a final thought, be sure to ask a tax professional if you aren't sure about your ability to deduct any rental losses, either now or in the future. For example, if you aren't sure whether you meet the IRS definition of an "active participant" or whether you have other types of qualifying passive income you can use your rental losses to offset (unfortunately, most capital gains don't count), these are things you'll want to make sure you get right.

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