Tax Tips
Take an Active Role in Using Passive Losses - October 2009
Richard Scrivanich - Partner
Many real estate investors have suffered setbacks from recent turmoil in the economy and financial markets. If you sold a property last year, you might not have included accumulated losses on your 2008 tax return. Similarly, if you sell investment property this year, you should remember to use any suspended passive activity losses on your 2009 tax return.
Passive activity losses
Even in good times, real estate investors may show losses from their ventures, for tax purposes. Depreciation deductions help to generate such losses, even if you receive more cash from rental income than you actually spend on running the property. In bad times, your losses may increase as rental income declines.
Either way, such tax losses are passive activity losses-losses from a business in which you do not actively participate. Under the tax code, you usually must treat rental real estate as a passive activity, even if you're the one who screens tenants and fixes the plumbing. You generally can deduct such passive losses only against passive activity income.
Example #1: Shannon Davis owns two rental properties. In 2009, she has a $20,000 loss from one property and $30,000 of taxable income from the other one. She can net these results and report $10,000 of passive income on her tax return for the year.
The $100,000-$150,000 question
Some real estate investors will have passive losses from one or more properties but no passive income. Can they deduct those losses? Yes, but they might have to wait for many years.
In most cases, taxpayers whose adjusted gross income (AGI) is under $100,000 can deduct up to $25,000 in passive losses. That $100,000 limit applies to both single and joint tax returns. Between $100,000 and $150,000 in AGI, your permitted loss gradually declines to zero.
In order to deduct any passive losses, you must meet certain conditions. You must have at least a 10% interest in the property. Also, you must own your share directly, not through an entity such as a limited liability company or a limited partnership. In addition, you must take part in some management decisions such as approving tenants and setting rent levels.
Example #2: Bryan Parker owns one rental property and makes management decisions. This property generates a $20,000 loss in 2009. Bryan's AGI in 2009 is $140,000. This AGI is 80% through the $100,000-$150,000 phaseout range, so he can deduct only 20% of the $25,000 maximum: $5,000. If Bryan can deduct $5,000 of his $20,000 loss, what happens to the other $15,000? He can't deduct it right away, but he can carry it forward to future years as a suspended passive loss.
Use it, don't lose it
If Bryan owns the property for many years, he may build up a large bank of suspended losses. When he disposes of his interest in the property, he can use all of his suspended losses. That's true no matter how large his AGI is that year. Therefore, if you sold rental property last year and did not include any accumulated suspended losses on your 2008 tax return, our office can help you recognize those suspended losses on an amended return. Similarly, be sure to recognize any suspended losses on your 2009 tax return if you sell rental property this year.
If you have any questions regarding the above discussed topic or any other tax matter, please feel free to give me a call at (562) 698-9891.
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