Deducting Rental Tax Losses - Can you do it?

Real Estate Agent with Virginia Real Estate

In my rental experience as a real estate agent in Central Virginia, most of the time, the first five years or so of rental property ownership generates a tax loss.  Usually, unless it is a property that the owner purchased for very little because of the physical condition and put a lot into fixing it up prior to rental, it is about year 5 or year 6 before increased rents begin to generate income for the landlord.

Now comes the real issue, can you take these losses on your tax return?  Answer...MAYBE.  (Maybe is the classic answer when dealing with taxes, because there is an exception to every rule in the tax code.)

Rental income and losses are considered "passive" income, as opposed to "active" income, basically meaning you didn't have to physically do anything to earn it, like you would in your job or profession where you work to earn the money.  Examples of other passive income are interest income, dividend income, or capital gains income.

Passive income is always taxable, as is generally any income.  But the catch is... passive losses are not always deductible.  Passive losses are only deductible to the extent you have passive income.  This means that you use passive losses to offset, or wipe out, passive income on the tax return, but if you have more passive losses than passive income, the passive losses must be carried forward to the next year.

Here is the exception... (I told you there was always an exception.)  With rentals, you can write off passive losses up to $25000 per year in excess of your passive income.

This is really huge if you are thinking about investing in real estate.  Basically if you are in the 30% tax bracket (25% federal + 5% state), you get back in your refund (or reduction in what you owe) an extra $0.30 for each $1.00 of loss that you had on that rental property.  It's like a big HUGE rebate.  For instance, if repairing the plumbing in that rental property costs you $1000, the IRS is paying $300 of it.

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