While IRS rules prevent many landlords from being able to deduct rental losses, there are important exceptions which can help those in the real estate industry.
It is extremely common for landlords to have rental losses, especially in the first few years they own a property. Indeed, IRS statistics show that over half of the filed Schedule E forms reporting rental income and expenses each year show a loss. If you have a rental loss, you have plenty of company.
Losing money in any business venture is never fun, but it can have tax benefits. As a general rule, you may be to deduct your losses from other income you have, such as income from a job or other investments.
Unfortunately, this general rule does not apply to rental losses. Complex IRS rules may prevent you from deducting all or part of your rental losses from the other income you earn during the year, which could end up costing you thousands of dollars in extra taxes. However, there are also important exceptions to the rules that were created to help small landlords and others in the real estate industry.
What Are Rental Losses?
You have a rental loss if all the operating expenses from a rental property you own exceed the annual rent and other money you receive from the property. If you own multiple properties, the annual income or losses from each property are combined (netted) to determine if you have income or loss from all your rental activities for the year. You report your rental income and deductible expenses on IRS Schedule E.
Often, you have a loss for tax purposes even if your rental income exceeds your operating expenses. This is because you get to depreciate (deduct) a portion of the cost of your rental property each year without having to lay out any additional money.
Rental Losses Are Passive Losses
Here's the basic rule about rental losses you need to know: Rental losses are always classified as "passive losses" for tax purposes. This greatly limits your ability to deduct them because passive losses can only be used to offset passive income. They can't be deducted from income you earn from a job or investments such as stock or savings accounts.
Passive income is the income you earn from rental real estate or other passive activities. An activity other than real estate is considered passive if you don't "materially participate" in it--that is, work at it for a minimum number of hours each year--usually 750 hours. Passive income does not include income from a job, a business you actively manage, or investment income. Thus, for example, you'd have passive income if you earn a profit from one or more rentals.
Without passive income, your rental losses become suspended losses you can't deduct until you have sufficient passive income in a future year or sell the property to an unrelated party. You may not be able to deduct such losses for years.
In short, your rental losses will be useless without offsetting passive income.
Exceptions to Passive Loss Rules
There are only two exceptions to the passive loss ("PAL") rules:
- you or your spouse qualify as a real estate professional, or
- your income is small enough that you can use the $25,000 annual rental loss allowance.
Property owners with modified adjusted gross incomes of $100,000 or less may deduct up to $25,000 in rental real estate losses per year if they "actively participate" in the rental activity. You actively participate if you are involved in meaningful management decisions regarding the rental property and have more than a 10% ownership interest in the property. This allowance is phased out for taxpayers whose MAGI exceeds $100,000 and eliminated entirely when it exceeds $150,000. Thus, it is useless for high-income landlords.
The other exception to the PAL rules is the one for real estate professionals. Unlike the $25,000 exception described above, this is a complete exemption from the rules--that is, landlords who qualify as real estate professionals may deduct any amount of losses from their other non-passive income.
To qualify for this exemption, you (or your spouse) must spend more than half of your total working hours during the year in one or more real property businesses--a minimum of 751 hours is required. In addition, you must "materially participate" in your rental activity. This requires that you work a certain number of hours at your rental activity during the year. For example, you would materially participate if you work at least 500 hours during the year at the activity. You can qualify in other ways as well.
If you own more than one rental property, you are required to materially participate for each rental property you own unless you file an election with the IRS to treat all your properties together as one single activity. This way, you can combine the time you spend working on each rental property to satisfy the material participation test. If you fail to file the election, you'll have to materially participate for each rental property you own. For most landlords, this is impossible to do, which makes filing an election very important.
For detailed guidance on this complex area of tax law, refer to Every Landlord's Tax Deduction Guide, by Stephen Fishman (Nolo).
FAQs
You can deduct up to $25,000 of rental losses on your tax return if your adjusted gross income is less than $150,000. If your adjusted gross income is less than $100,000, you can deduct the full $25,000. If your adjusted gross income is between $100,000 and $150,000, you can deduct up to ($150,000 – Your Income)/2.
What is the $25,000 rental loss limitation? ›
If you actively participated in a passive rental real estate activity, you may be able to deduct up to $25,000 of loss from the activity from your nonpassive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities.
Can you offset rental losses against ordinary income? ›
Ordinary income is considered active and can't be offset by passive losses. But losses don't automatically qualify as passive if you own a rental property. If you are an active participant in the rental property, losses can fall under a special allowance, which does offset ordinary income.
Are self-rental losses deductible? ›
The IRS considers losses from rental real estate activities to be passive and passive losses cannot be deducted against non-passive income sources (e.g., income from the operating entity).
Do rental losses carry over? ›
Carrying it Forward
Now let's get back to the question of this article – whether losses on rental property can be carried forward. The answer is yes. You can carry forward those losses until the entire amount is used up. But again, passive losses can only be used to offset against passive income.
Can real estate professionals deduct rental losses? ›
Benefits of real estate professional status
They can use rental losses to offset non-passive income. Another benefit of qualifying for real estate professional status is that any rental activities that aren't subject to PAL rules are also not subject to the 3.8% net investment income tax (NIIT).
How many years can you carry forward a rental loss? ›
They can be carried forward indefinitely into future years until they've been used up against future passive income. There can be exceptions regarding the use of those passive losses against earnings. One is if you're a qualified real estate professional and materially participate in rental operations.
What happens if my expenses are more than my rental income? ›
If your rental expenses exceed rental income your loss may be limited. The amount of loss you can deduct may be limited by the passive activity loss rules and the at-risk rules. See Form 8582, Passive Activity Loss Limitations, and Form 6198, At-Risk Limitations, to determine if your loss is limited.
Can I deduct rental losses if I file married filing separately? ›
Special loss allowances
You might have passive-activity losses from rental real-estate activities in which you actively participate. If so, you're allowed a special allowance based on your filing status: Single or married filing jointly — $25,000. Married filing separately and lived apart all year — $12,500.
What are unallowed losses on rental property? ›
Rental activity is normally considered a passive activity. Because of this, any losses on rental property that cannot be offset by rental property income are disallowed (“unallowed”). Unallowed losses are not deductible in the current year but can be carried forward to future years to offset future passive income.
No. If your income property was vacant (or rented for a limited time) and spent the rest of the year vacant, you cannot deduct the vacancy as a loss of income. Typically, you are able to deduct the necessary expenses to maintain the property, including depreciation.
How is rental income taxed by the IRS? ›
You generally must include in your gross income all amounts you receive as rent. Rental income is any payment you receive for the use or occupation of property. Expenses of renting property can be deducted from your gross rental income. You generally deduct your rental expenses in the year you pay them.
How much loss can you write off on rental property? ›
When your income is under a certain threshold, you may qualify for the real estate loss allowance. If your gross adjusted income is $100,000 or less, you may deduct up to $25,000 of rental losses. But for you to use this allowance, you must actively participate in the rental, among other conditions.
Can you deduct home insurance from rental income? ›
Here's the skinny: You can only deduct homeowner's insurance premiums paid on rental properties. Homeowner's insurance is never tax deductible your main home. It's possible that some homeowners are thinking of the home mortgage interest deduction.
What losses are not deductible? ›
However, there are several types of losses that would not qualify for deduction: Those incurred due to long-term processes, such as erosion, drought, decomposition of wood, or termite damage. Any loss that arises from what the Internal Revenue Agency (IRS) considers to be a "foreseeable" event.
Is there a limit on schedule E losses? ›
If it is less than $100,000, you can claim up to $25,000 of losses reported on line 26 of your Schedule E. If you make between $100,000 and $150,000, the loss amount starts phasing out. If you make over $150,000, the loss on line 26 cannot be claimed.
Can you deduct rent from taxes? ›
Rent is the amount of money you pay for the use of property that is not your own. Deducting rent on taxes is not permitted by the IRS. However, if you use the property for your trade or business, you may be able to deduct a portion of the rent from your taxes.
Can I deduct mortgage interest on rental property? ›
As a rental property owner, you can claim deductions to offset rental income and lower taxes. Broadly, you can deduct qualified rental expenses (e.g., mortgage interest, property taxes, interest, and utilities), operating expenses, and repair costs.
