Dear Tax Talk:
I own four properties -- the one I live in, one I own with my daughter and two rental properties. I received an annuity from my dad, who passed away last year, and it put my income over $150,000. I was told I could not use any of my properties as write-offs, which cost me about $15,000 in tax refunds. Is this correct? And what could I do to fix this or make sure it doesn't happen in the future?
Rental real estate is termed a passive activity for tax purposes. Typical taxpayers cannot use losses from rental real estate to offset other types of income, such as income from working, interest and dividends, and gains from the sale of assets that produce dividend or interest income.
As with any general rule, there are exceptions. A taxpayer who is considered a real estate professional can offset real estate losses against the types of income mentioned in the preceding sentence. I don't think you would be considered a real estate professional based on four units -- two of which are personal use -- unless you're otherwise involved in real estate, such as a Realtor or developer.
The second exception to the loss limitation applies to all taxpayers regardless of profession. (If you're a real estate professional you don't care about this exception since you don't have a loss limitation.)
It may be easier to illustrate the loss limitations through an example. Suppose you rent your former home and have $15,000 in rental income and $25,000 in expenses, such as real estate taxes, insurance, interest and depreciation. Your loss would be $10,000, and normally could not be deducted against other income (you don't even get $3,000 like you do from capital losses).
An exception allows taxpayers with modified adjusted gross income, or MAGI, of less than $100,000 to utilize up to $25,000 in real estate losses against other income. The $25,000 maximum is reduced by $1 for every $2 MAGI exceeds $100,000, so that taxpayers with MAGI in excess of $150,000 cannot utilize losses.
In our example, if you had MAGI of $100,000, you could use the full $10,000. If your MAGI was $140,000, the $25,000 max would be reduced by one-half of the $40,000 overlimit so that the maximum you could deduct would be $5,000, because this is less than the actual losses of $10,000. The remaining $5,000 that would not be allowed could be carried over in a subsequent year when the MAGI limits permit, or when the property is sold.
Accordingly, the problem should
fix itself for you in 2008, when your MAGI once
again falls below the threshold. Any losses you
couldn't claim in the prior year would carry over
to 2008 and be allowed then, if you're within
the overall $25,000 cap.