What I said that we had quite a bit of suspended losses early on. But as interest rates went down, and rents went up, we had net rental income,instead of deductions for a change. So we had passive income ON TOP of active income which exceeded the 150K. At this point, the suspended loss was used to offset the passive income.
At no time was the suspended loss applied to ACTIVE INCOME.
What I further said was this suspended loss was used up over time, making it unneccessary for the CPA to segregate the suspended loss by property.
Finally when we sold, we no longer had any suspended loss.
I understand that one can deduct $25,000 of rental loss if the combined income of husband and wife is less than $100,000. The amount is porated if the combined income is between $100,000 and $150,000. When the combined income is over %150,000, there will be no deduction.
A friend of mine advised me to form a corporation or LLC to take advantage of the deduction. It is because in a corporation, the paper loss of a rental property can be deducted from one’s income.
Since I am a salaried employee, how do I place my income into a corporation to take advantage of the paper loss?
If I set up the LLC now, can I deduct the paper loss from the previous month?
Re: deduction of income tax by rental loss - Posted by Frank Chin
Posted by Frank Chin on April 29, 2005 at 07:18:47:
Techin:
You described the “passive activity limitation” rules perfectly. Unfortunately, your friend gave you bad advice on the other part.
When you place properties into a Corp, you run into other tax issues such as double taxation when you sell, employment tax issues to name a few.
If you are a salaried employee, the only way I can think of is to have your employer pay fees to a corporation you designate. Then, the IRS does not like the idea of employers paying consulting fees instead of a salary.
There is a “Real Estate Professional” loophole you might want to check out:
What if I actively manage the rental property, ie, I receive the rental fee, I order the repair, etc? Does the passive loss rule still apply? Or I can reduct the loss (including the depreciation) from my salary?
If I form a partnership, and the house is under the partnership, would I have a better chance of deducing the loss?
I also have entertained the idea of being a real estate professional. However, my wife would like to continue her full time job, so am I. According to the 750 hr/year rule, we are not qualified.
My friend deeds all his properties into an LLC, and claims he can deduct his income, which is sizable, against the paper loss. When I asked for more detail, he told me his accountant helps him make the arrangement. Because of the distance ( I am in CA, and he is in LA), I cannot visit his accountant.
A follow-up question: If I cannot deduct the depreciation loss, do I have to pay the tax due to these loss when I sell the property?
Be careful of the advice you take. Everyone knows someone who pays no taxes because he or his accountant know special loopholes no one else knows about.
Frank’s advice is not correct, either. The losses are suspended until you dispose of the property in a taxable transaction. The losses are not added to basis, but allowed as a deduction against other ordinary income. The gains are 1231 gains, subject to tax (under current law) at 15% except for the depreciation on 1250 property which is taxed at 25%. If there happens to be any 1245 gain, it is subject to tax at ordinary income rates.
I accumulated quite a bit of “suspended losses”, for a while. But as interest rates dropped and rents increased during the 90’s, I was permitted to offset net rental income against the suspended losses, even with active income exceeding 150K at certain points, eventually using all of it up, long before the eventual sale.
As I recall, I asked my CPA to allocate the suspended loss to each property in the event a sale takes place before it was used up, but he failed to do so. This is an important step if one owns several properties. I also asked what happens if there is anything left at the time of sale, and my CPA mentioned he’ll add it to the basis at the time of sale.
Unfortunately, this is another point that I failed to double check the CPA, and I since confirmed the rules are somewhat different.
I am sorry, if a passive activity generates income in years after it has passive losses, the suspended losses can be used to offset that income. It cannot be used to offset other income such as wages or interest income.