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Are Losses On Rental Properties Deductible?

For those people who have business ventures that offer residential real estate to renters, figuring out whether this business provides a profit or not is sometimes difficult.  Even more daunting is determining where to file them on a tax return and how to deduct any losses.  In most cases, the amount of profit or loss is simply the difference between the total of rental income less all of the expenses incurred to support the property.  This activity is usually reported on Schedule E of your income tax return. So, are losses on rental properties deductible?  Losses are normally deductible. However, there are two sets of rules that may limit the amount of loss you can deduct, and there are limitations to these deductions.

Rules for Deducting Loss on Rental Properties

If you have a loss from your rental real estate activity, there are two sets of rules that may limit the amount of loss you can deduct. You must consider these rules in the order shown below. More details can be obtained from IRS Publication 527.

  1. At-risk rules. These rules are applied first if there is investment in your rental real estate activity for which you are not at risk. This applies only if the real property was placed in service after 1986.
  2. Passive activity limits. Generally, rental real estate activities are considered passive activities and losses are not deductible unless you have income from other passive activities to offset them. However, there are exceptions.

Most of the time, any loss from an activity subject to the at-risk rules is allowed only to the extent of the total amount you have at-risk in the activity at the end of the tax year. You are considered at-risk in an activity to the extent of cash and the adjusted basis of other property you contributed to the activity and certain amounts borrowed for use in the activity. Any loss that is disallowed because of the at-risk limits is treated as a deduction from the same activity in the next tax year.

Limitations to Deductions

Most rental real estate activities are passive activities. For this purpose, a rental activity is an activity from which you receive income mainly for the use of tangible property, rather than for services.  Deductions or losses from passive activities are limited. You generally cannot offset income, other than passive income, with losses from passive activities. Also, you cannot offset taxes on income, other than passive income, with credits resulting from passive activities. Any excess loss or credit can be carried forward to the next tax year.

Please reach out to us with any tax questions you may have in relation to rental properties and deductions, simply call (410) 824-1853.

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