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Dear Tax Talk,
I got married in 2011. My taxable income is $106,000 and my wife’s is $50,000. We just got our taxes done, and because our combined income was more than $150,000, our tax preparer told us we could not use any of our business losses from our rental houses. This fact made our taxes increase for 2011 by $4,700. Is our tax preparation guy correct, or is he missing something?
Your tax guy is correct. The more you make, the fewer tax breaks you get. One of those tax breaks that goes away as your income exceeds certain thresholds is the allowance of passive losses against nonpassive and portfolio income such as salary and interest income.
Rental real estate is considered a passive activity, the losses from which are only allowed against passive income. Passive income is income from business activities in which you don’t materially participate, including other rental activities.
As always is the case in tax law, there are exceptions. Taxpayers whose modified adjusted gross income, or MAGI, is less than $100,000 can claim up to $25,000 in rental losses. The $25,000 cap is reduced $1 for every $2 a taxpayer’s MAGI exceeds $100,000. For example, a MAGI of $110,000 exceeds $100,000 by $10,000 so the $25,000 limit is reduced to $20,000. At $150,000, the reduction to the cap is the full $25,000, which is your situation. Any losses you can’t claim are carried over to future years and allowed as a deduction against passive income, including gain on the sale of the property. If your income were to go below the thresholds, then you would also be able to claim the losses, including those carried over.
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To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.