What Do I Need To Know About Real Estate Losses?

Jul 20, 2022

Real estate is tricky and is usually treated much different than a typical business. This is just one Blog Post and Podcast Episode in an entire guide we put together on real estate taxes.

If you have not checked out our other content around real estate taxes, do so now by visiting: The Ultimate Guide to Real Estate Taxes

In this post we are going to specifically be discussing real estate losses.

Why Do Rental Properties Often Produce a Loss?

Last week we talked about how depreciation works in real estate. If you haven't checked that out, do so now.

Essentially, because of depreciation often times rental properties will have a positive cash flow (money in your pocket) but will be showing a loss on paper because of the high depreciation you can take early on in the properties life.

You also have regular operating expenses (over and above depreciation) which all add into this and help create that loss.

Losses from real estate are considered "passive losses". We did a Blog and Podcast on passive income that I also recommend you check out here.

How Are Passive Losses Handled?

The biggest downfall to passive activity is this idea of passive activity loss rules.

Passive losses can only offset other passive income. You cannot use a passive loss to offset earned income, capital gains (unless a cap gain from a passive activity), or portfolio income. 

Essentially, if you have a rental property (passive) and you have a loss in it due to high depreciation, you can only offset that loss against other passive income (rental activity or businesses you do not actively participate in) but you cannot use that loss to offset earned income (W2) or non-passive capital gains. 

Now here is the good thing! If you have passive losses that you do not have enough passive income to offset, they are not gone forever.

Unused passive losses (aka suspended losses) can be carried forward to future years when you may have passive income OR when you sell a rental property for a gain.

Even though you may not be able to use your passive loss right away, rest easy knowing that you'll be carrying it forward to offset future income until it has been utilized fully. Also remember that you are probably having a positive cash flow NOW without having to pay taxes on it. This is great news!

How Can I Utilize Passive Losses?

Although passive losses can only offset other passive income there are some strategies to fully maximize those losses. These include:

  1. Being an Active Real Estate Investor
    • If you are under certain income limits you can claim up to $25,000 in rental real estate loss allowance from the property, if you "actively participate" in managing it. We talk about this further next week. 
  2. Become a Real Estate Professional
    • Qualifying as a real estate professional allows you to fully deduct passive losses against your ordinary income. There are various requirements that need to be met to qualify. We talk about this further next week.
  3. Generate More Passive Income
    • If you are a business owner is there part of your business that you do not actively participate in? Could you split that off into a separate passive entity for you?
    • Do you have another property you could sell at a gain to use the losses against?
    • Do you have a highly appreciated asset you could sell at a gain to use the losses against?
    • Can you invest in a high cash flow passive activity that the losses can be used to offset?

At the end of the day we know that at some point you WILL be able to utilize your passive losses it just depends on when. In a perfect world we would be able to utilize them right away and offset any other types of income we have but in order to do that there may be some adjusting and planning you need to do as we mentioned above.

Again, this is just one Blog Post and Podcast Episode in an entire guide we put together on real estate taxes.

If you have not checked out our other content around real estate taxes, do so now by visiting: The Ultimate Guide to Real Estate Taxes

We also have a full section in our Tax Minimization Program specific to strategies around rental properties!

 

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