Rental property income gets reported on line 17 of your 1040 tax return as taxable income. If you make $10,000 on your rental activities, the Internal Revenue Service requires you to pay your marginal income tax rate on it. If you lose money on a rental, though, your ability to take that loss to offset other gains is more limited, based on the IRS' treatment of it as passive income.
When you own multiple properties, the IRS has you combine their individual profits and losses into a total income or loss from your rental property activities. Since you combine the properties, you can use a loss from one to offset another, thereby reducing your total taxable income. For example, if you make $18,000 on one rental property, but lose $6,000 on another, you'd end up with a total profit of $12,000, which would be part of your taxable income.
Real Estate Professionals
When you're a real estate professional, your rental income and losses get treated as a part of your real estate enterprise, all of which is classed as active income. In this instance, your rental losses can be applied to reduce your taxable income on a dollar-for-dollar basis. You need to pass three tests to be considered a real estate professional by the IRS, though. You need to spend at least half of your productive time in the practice of real estate. The time you spend doing real estate must be at least 750 hours per year. Finally, you can't be an employee anywhere other than at a real estate-related company of which you own 5 percent or more.
Passive Activity Losses
If you aren't a real estate professional, you can write off up to $25,000 of your rental property losses, called passive activity losses by the IRS, against other income. To qualify for this write-off, you need to be actively involved in running your rental properties, although you can have a third-party manager helping you. You also need to have an Adjusted Gross Income that is $100,000 or less. Your ability to claim the passive activity loss deduction starts going down by $1 for every $2 of income that you have over the $100,000 threshold. If your AGI is $150,000 or more, you won't be able to claim any losses.
Any rental property losses that you have left after your passive activity loss deduction, if any, don't go away. You get to save them up for use in a future year. The IRS lets you carryforward any passive activity losses to offset other passive income. For example, if you have $5,000 in unused losses this year and a $9,000 profit next year, you'll be able to use the losses to turn the $9,000 profit into a $4,000 taxable profit. You can even deduct this year's losses in the future if your income goes down so that you're eligible to claim them.
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