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Date: June 23, 2011
Subject: Rental Property Loss Deductions

This is
G&G Associates Tax & Financial Consulting

Tax Tip of the Week
Rental Property Loss Deductions

Imhotep (Wisdom to You) G&G Readers,

If you have a tax loss on your rentals, you probably want to deduct that loss right now.

What you want and what you get may not match. Tax law contains passive-loss rules that often prevent current-year deductions for rental property losses.

Two Loss Preventers

Your deductible tax losses from rental real estate face two intertwined loss-deduction preventers:

1. Making too much money

2. Not working on the real estate hard enough

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Making Too Much Money

If you actively participate in your rental real estate activity, you may deduct rental losses of up to $25,000 per year. The law phases out this limited deduction at the rate of 50 cents on the dollar for each dollar of modified adjusted gross income in excess of $100,000, with full phase-out reached at $150,000.

Not Working Hard Enough

Tax law treats rental activities as passive activities. With certain limited exceptions, you may not deduct passive losses against your business or portfolio incomes.

One exception to the rental-is-passive rule is the real property business. If you can fit this exception, your real estate rental activity is a trade or business and, if you materially participate, your losses are deductible.

You qualify as being in the real property business if:

1. you spend more than one-half of your personal service time in real property trades or businesses in which you materially participate, and

2. you spend more than 750 hours of services in real property trades or businesses in which you materially participate.

If you file a joint return, either you or your spouse must separately qualify as being in the real property business by satisfying tests 1 and 2 above. (For material participation, you may look to the combined efforts of you and your spouse, if married.)

Actual Case Studies:

Mr. and Mrs. Anyika

Mr. Yusufu Yerodin Anyika is employed as an engineer. He works 37.5 hours per week, 48 weeks per year. His wife, Cecelia Francis-Anyika, works as a nurse 24 hours per week. On their joint tax returns, they reported $133,117 and $167,630 as wages for the two years before the court.

Mr. Anyika buys, renovates, manages, and sells rental properties. During the tax years before the court, Mr. Anyika owned two rental properties.

What Happened?

Start with the not-working-hard-enough test. Mr. Anyika is the rental property person. How hard does he have to work on the rentals to be in the real property business?

Answer: More than the 1,800 hours a year that he works as an engineer (37.5 hours times 48 weeks). As you would expect, Mr. Anyika failed this test. Thus, his last hope for freeing up his passive losses for current-year deductions rests with the making-too-much-money test.

To apply the making-too-much-money test, assume that the wages equal modified adjusted gross income. Since the ceiling is $150,000, the Anyikas have only one year that qualifies for the active participation rental loss allowance. Here, in the year when their modified adjusted gross income is $133,117, they can deduct up to $8,442 in rental property tax losses [($150,000 minus $133,117) times 50 percent equals $8,442).

Carry forward:

Any rental property passive losses that are not deductible currently carry forward to future years. Thus, the losses are not lost, but the inability to deduct the losses currently reduces the after-tax rate of return on the rentals.

Be Alert!

Do you qualify to deduct your rental property losses? If not, how much does the fact that you cannot deduct losses reduce your rental property profits? To find out, contact G&G Associates Tax & Financial Consulting services to find out if you can or not.

Visit our website for more information or contact us today to set your appointment if you need a “TAX” OR “FINANCIAL” one-on-one consultation.

Until the next time!

Ankh Uja Snb (Life, Strength, & Health),

Asar Gary Gray
Tax & Financial Consultant, RFC
G&G Associates
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