Passive Income

[Marc]

We bought our retirement home last year; about 2.5 years prior to actually retiring. I was lucky and had it rented before we even closed on house. When I did my return this year I was surprised to find out I couldn't deduct any of the loss due to limitations on passive loss. Wasn't a big deal this past year as it was only the depreciation that caused the loss. This year, due to property taxes and a small amount of maintenance, I will have a loss before depreciation.

First, I want to make sure that I didn't do anything stupid. I researched IRS pubs and used TaxAct to complete my return; they both said the rental house is passive loss. Second, I would like to know of any sources of passive INCOME that could be offset by these losses. Although most of my funds are in Tax Deferred accounts, I do have some funds available that could be invested differently (currently in index ETFs). So, are there could investments that put off passive income or is it not worth the effort?

thanks,

Marc

 

[Senator]

Make sure you take all your expenses. Including any travel and maintenance. I find it near impossible to buy a SFH and make money on it. Especially after taxes, interest and insurance.

A rental income is passive, unless you manage it yourself. Or at least make the major decisions. You have to be actively engaged in it. You have to have money at risk. Most people, even if they hire a property manager, can be actively involved.

 

[Another Reader]

It's not that difficult to meet the actively engaged test. Read the IRS publication and look at some of the articles by CPA's on this subject. I have property management for most of my out of state rentals, but I fly out quarterly to drive by them, make all the capital improvement decisions, and review tenant decisions. I do manage some myself and I have local property as well, so it is not likely I would be challenged anyway, but you should be able to meet the criteria of active participation.

Now, real estate professional, that's a level that is much more difficult to reach and prove. Reportedly the IRS likes to audit those folks because of the high percentage of recovered revenue the audits yield.

 

[Souschef]

Make sure you take all your expenses. Including any travel and maintenance. I find it near impossible to buy a SFH and make money on it. Especially after taxes, interest and insurance.

A rental income is passive, unless you manage it yourself. Or at least make the major decisions. You have to be actively engaged in it. You have to have money at risk. Most people, even if they hire a property manager, can be actively involved.

I rented out my condo, and checked the actively engaged box.

 

[Marc]

Ok, now I am really confused. I checked "actively engaged" but that still left it as a passive loss. I need to go back and read some more.

thanks!

Marc

edited to add: I think i know the problem; our AGI (and also MAGI) were above $150K which eliminates the $25K of passive deductions that I could have taken. Is this the reason? If so, I will manage my income at <100K my first two years of retirement and could then take the deduction if it is allowed to carry over.

edited further to add: I should keep my taxable income to 125K this year so I should be able to deduct around $12,500 loss. This will totally cover 2016 loss; do I also get to cover last year's loss?

 

[rayinpenn]

I have been in the same Alternative Minimum Tax boat for ten years - pay attention to loss carry forward.


Sent from my iPad using Early Retirement Forumh

 

[pb4uski]

I suspect that you probably actively participated in managing the property if you negotiated the rental, etc.

Exception for Rental Real Estate With Active Participation

If you or your spouse actively participated in a passive rental real estate activity, you may be able to deduct up to $25,000 of loss from the activity from your nonpassive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities. Similarly, you may be able to offset credits from the activity against the tax on up to $25,000 of nonpassive income after taking into account any losses allowed under this exception.

Example.

Jane is single and has $40,000 in wages, $2,000 of passive income from a limited partnership, and $3,500 of passive loss from a rental real estate activity in which she actively participated. $2,000 of Jane's $3,500 loss offsets her passive income. The remaining $1,500 loss can be deducted from her $40,000 wages.

The special allowance is not available if you were married, lived with your spouse at any time during the year, and are filing a separate return.

Active participation. You actively participated in a rental real estate activity if you (and your spouse) owned at least 10% of the rental property and you made management decisions or arranged for others to provide services (such as repairs) in a significant and bona fide sense. Management decisions that may count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and other similar decisions.

 

[kaneohe]

..........................................
edited to add: I think i know the problem; our AGI (and also MAGI) were above $150K which eliminates the $25K of passive deductions that I could have taken. Is this the reason? If so, I will manage my income at <100K my first two years of retirement and could then take the deduction if it is allowed to carry over.

edited further to add: I should keep my taxable income to 125K this year so I should be able to deduct around $12,500 loss. This will totally cover 2016 loss; do I also get to cover last year's loss?

Yes, you have the reason correct. See F8582 which tracks how much loss you are allowed to deduct each year and your total loss including carryover losses.
You are allowed to deduct the lower of the two and any excess, if any, is carried over to the next year. https://www.irs.gov/pub/irs-pdf/f8582.pdf