Rental Real Estate is considered a passive activity under the tax code and this means losses may not be deductible against many other types of income. Current year deduction of rental property losses are only allowed for tax payers that have profits from rental activities, with the following exceptions; tax payers that are engaged in a real estate trade or business (generally realtors) or tax payers who’s AGI (Adjusted Gross Income) is less than $100,000 and have active participation in them may be able to deduct up to $25,000 of rental activity losses against their other income. The amount of allowable loss is reduced by $1.00 for every $2.00 by which AGI exceeds $100,000. This means that when AGI reaches $150,000 the deduction is no longer allowed.
It should be noted while a deduction for losses of rental activities may not be allowed, unused losses are carried forward for use when rental profits occur or the rental activity is disposed of. It is important to keep careful track of any unused or un-allowed losses. You must also have basis in rental activity before a deduction is allowed. Simply put, this means you can’t deduct a loss which is greater than the amount you have invested plus amount you have at risk.
Generally, rental income is reported in the year received, meaning any last month’s rent, along with any rent paid in advance received must be included in year it is received. If you receive property or services as rent, instead of money, the fair market value of the property or services needs to be included in your rental income. Do not include a security deposit in your income when you receive it if you plan to return it to your tenant at the end of the lease. However, if you keep all or part of the security deposit during any year because your tenant does not live up to the terms of the lease, include the amount you keep in your income records for that year.
It’s important to remember, Depreciation is NOT elective and, failure to take depreciation even if no tax benefit is realized during the current year will result in adverse tax consequences when the rental activity is sold or disposed of. Tax law requires the tax basis of property sold to be reduced by depreciation allowed or allowable. Bear in mind, rental losses (which include depreciation) that cannot be used due to passive activity rules or lack of basis can be carried forward and, may reduce taxes in later years.
Rental activities are a complicated area of the tax law, proper record keeping and proper tax reporting are important to avoid excess and or the losses of future benefits. This information should help you gain a better understanding of this complicated area of tax law. It’s is always advisable to consult a tax professional before making any decisions and to review your particular facts and circumstances