savings from rental property losses
My wife is an attorney and I'm a real estate
agent. We are trying to figure out the best way to decrease our
taxes. Our household income ranges from $150,000 to $220,000 and
we file jointly. We are maximizing our 401(k) and other savings
vehicles. We have done our homework and have found a great investment
property that could pay for itself. Is purchasing rental property
a good way to decrease our tax base? -- Christopher
For most folks at your level of income, a loss from rental property
would not be a big benefit income tax-wise. Losses from rental activities
for most individuals are not allowed to offset other income such
as wages if their adjusted gross income exceeds $150,000. A significant
exception exists for a real estate professional such as you.
While entering into any business with the intention
of incurring losses usually is not a formula for success, the real
estate business is different. Most leveraged real properties will
incur a taxable loss during their operation. Generally, this comes
about by the allowance for depreciation of the property and sometimes
from negative cash flow.
In figuring your profit from the property, you're
allowed a deduction of your cost at roughly 4 percent per year.
On a $200,000 property this means you have an approximate $8,000
tax deduction that does not come out of your pocket.
The other side of the coin is that although you're
losing for tax purposes, your property is usually appreciating in
value annually. This appreciation is not taxed until you sell the
property and you can defer the tax even then by doing a like-kind
exchange. In addition, as the property appreciates, you can
borrow against it tax-free and buy more property.
While most people can't use the tax deduction due
to passive activity limitations when their income exceeds $150,000
Revenue Service Publication 925), a significant exception exists
for a real estate professional. A real estate professional is generally
a developer, property manager or broker. If you're in this category,
your losses would not be limited under the passive activity rules.