The tax benefits of real estate losses depend on the type of losses incurred. There are two types of real estate tax losses. One type is the loss incurred from the operation of a rental property. This is where the expenses exceed the income. This is considered a passive loss and has specific guidelines and limitations. The other type of loss comes from selling a property for less than its original cost. This is considered a capital loss and also has specific rules relating to its tax treatment. The IRS provides free publications regarding all real estate losses. They can be downloaded from their website at www.irs.gov.
Losses From Rental Properties
Losses from rental properties are considered passive losses as defined by the IRS. Passive losses are limited to $25,000 per year, which can be used to offset nonpassive income, such as wages or profit from a business. For example, if you have losses from rental properties totaling $30,000 for the year, and you have wage income of $75,000, you might be able to deduct $25,000 of the loss against the wage income. There are rules that limit this loss based on your income.
Losses From the Sale of Real Estate
Real estate is considered a capital asset and, therefore, losses from a sale of real estate are considered capital losses and must be used to offset capital gains. A capital loss occurs when the sale of a property exceeds its cost basis. The cost basis of a property is the purchase price, plus the cost of any improvements, less any depreciation deducted on the property. For example, if you paid $200,000 for a property, added $50,000 in improvements, then deducted $10,000 in depreciation expenses, your cost basis would be $240,000. If you sold the property for $175,000 you would show a $65,000 capital loss ($175,000 less $240,000).
How to Report Losses
Losses from the operation of rental properties should be shown on schedule E of the federal tax return. On this form, you list the income and expenses for each rental property. This is similar to a profit and loss statement. The net gain or loss from each property is then combined to give you one total. If this is a loss, it is carried forward to the first page and used to offset income, subject to certain restrictions. Losses from the sale of property are shown on schedule D, which is used for capital gains and losses. Losses on real estate are deducted against all other capital gains. If there is a net loss, the IRS permits a deduction of $3,000 against ordinary income, such as wages. Any unused losses must be carried forward to the next year.
Tax planning for real estate losses is crucial since certain limitations apply. For example, since net capital gain losses are limited to $3,000 after offsetting capital gains, you might want to defer the loss to a future period when you might have larger capital gains. You should contact a tax professional, such as a CPA or enrolled agent, who can advise you regarding taking the proper deductions for real estate losses. On rental properties, you should keep track of the income and expenses and categorize each expense--such as interest, repairs, landscaping and utilities--because you’ll have to show these expenses on your schedule E.