Thursday, February 11, 2010

RENTAL and other Unallowed passive losses

As a rule for many taxpayers, you can deduct up to $ 25,000 in rental losses. However if your "modified" adjusted gross income is $ 150,000 or more you get nothing. If your MAGI is less than $ 150,000, you will get all or part of the $25,000 maximum deduction. I won't go into the difference between MAGI and regular AGI. That's a whole 'nother story.

Here are some examples:

EXAMPLE # 1: Your MAGI is $ 140,000. $150,000 - $ 140,000 = $ 10,000. You can take half of the $ 10,000, not to exceed your actual loss. So if you lost $4000, you could take it all. If you lost $ 6000, you could only take $ 1000 and carry the loss forward to next year's tax return.

EXAMPLE # 2: Your MAGI is 90,000. $ 150,000-$90000 = $60,000. Half is $30,000, but you can't take more than the $ 25,000 maximum. You can carry forward any loss in excess of $ 25,000. If the loss is $25000 or less, then you can take it all in the year of the loss.

If you sell the property in some future year, you can then take all of the losses you carried forward in the year of the sale. So if you always made over $ 150,000 and had losses every year, then you would finally get a big deduction in the year of the sale.

If you have several properties and sell one of them, you only get the unallowed loss attributable to that one property in the year of the sale. Unallowed losses are allocated among all properties each year. If you have four properties and lose $ 20000 on three of them and make a profit of $ 4000 on one of them, you could offset the $ 4000 gain so it would not be taxed, but would reduce your loss carry-forward to $ 16,000.
Later you sell one of the properties. You would have needed to allocate the $ 20,000 to the three properties. Assume $6000 for one, $5000 for another and $9000 for the other one.
The unallowed loss would be split proportionately 16/20 (or 80%) X 5000 for the first one, etc.
So if you sold the one with the $9000 loss you would have $7200 carried forward and deductible in the year of the sale.

If you have losses and gains every year with multiple properties, you will need to keep a running total of any unallowed losses on a property-by-property basis. Some years you may have some gains which absorb part of the prior losses. This means that there is a very good chance of a miscalculation.

You probably should find a CPA to do all this for you. Those of us who do a number of tax returns have tax software programs that do all of these calculations and determine the carryforward amounts on a cumulative basis. For us, the allocations and MAGI calculation is no problem since the computer knows how to do it. What is important is to know how to feed the figures into the computer to get the right results and create the proper forms. My computer program automatically creates the Form 8582, Passive Activity Loss Limitations, which must be filed with Form 1040 if you have unallowed losses of this type.

NOTE: There are other types of passive losses besides rental losses. For example if you are a passive investor in a partnership or S-corporation that has losses, they are passive and cannot always be taken. Once I had a client with losses in about 20 partnerships and S-Corporations that were carried forward until one year he had a big profit and was able to offset a lot of the profit with the losses that were carried over from the prior years.

1 comment:

Holly P. Thomas said...

I am a financial planner and this is the best answer I have found to my question about my client's large prior years' unallowed losses. Thank you for making it so clear and covering all the bases. He has a CPA but he has not been available to help us strategize the sale of the properties. Now we have a better idea. Thank you!