Can Deductions Exceed Rental Income?

Question

I am wondering what happens if the expenses towards a rental property exceed the amount you get in rental income, what happens that that excess dollar amount?

I am currently house hacking (living in one unit of a duplex I just purchased). I will be sticking quite a bit of money into the property this fall that I would like to write off when doing my 2023 taxes. I am realizing that since I just bought the place, I won't have much rental income for this year - therefore, the expenses would exceed the income. Am I able to apply those expenses toward my W2 income at all?

I'm wondering if I should push some of these projects off until 2024. Any advice is welcome.

Jon Schwartz · Answer

@Spencer Krautkramer, definitely consult with a CPA who understands real estate. If you're putting money into fixing up the property, that's almost definitely capital expenditure, which you don't write off against rental income. Capital expenditure is added to the cost basis of the property.

For example, if you buy a $300,000 property and put $100,000 into repairing it, then sell it for $600,000 at some point, your capital gain is only $200,000 because your cost basis was $400,000 ($300K purchase price + $100K capex).

David M. · Answer

@Spencer Krautkramer

Applying passive losses against your W2 income is pretty difficult.  If your AGI is over $150k you pretty much definitely can't.

However, your losses are carried over as Passive Allowed Losses (PAL).  Its the same concept as carryover capital gain losses.  You can use these PAL's against future 'positive' income, or just keep "racking them up" year over year.  When you dispose of your interest in the property, i.e. sell, then you will realize the racked up PAL.

So, don't worry, they aren't lost.  Of course, consult with a qualified professional.  I'd be happy to chat with you in the mean time.  Good luck.

Theresa Harris · Answer

You should also check what is a capital expense vs current expense (I'm in Canada, terms may be different in the US).  Most major renos would generally fall under the capital expense category as you are improving the property which you can deduct when you sell the property.  Repairs are a current expense and you can deduct them in the tax year they are incurred.

Dan H. · Answer

The posts have good information related to how cap ex are deducted and banking passive allowed loses for future years.

To summarize cap ex are depreciated and if your income is above a threshold and losses (including depreciation) exceed revenue, the losses are banked for future years.  However, if you qualify as a real estate professional you can deduct these losses against income including W2 income.  IRS specifies requirements to be an RE professional and it is near impossible if you have a full time job that is not RE.  However, if you have a spouse that does not have a full time w2 job, they may be able to qualify as an RE professional.  When I had my engineering W2, my wife qualified as an RE professional.. I suspect we both qualify now that I “retired” to do RE and have more time for friends/family and travel. good luck

Ray Hage · Answer

Unfortunately, no, you can't deduct losses against you W-2 active income. Do you have any other properties you could deduct the loss against? If not, I do understand you are able to carry some of the losses forward but you will want to consult a good experienced accountant on that.

Eric Williams · Answer

Remember depreciation begins when the asset is placed in service. Regs 48

Consider that despite having purchased it and made improvements, it may not actually be yet depreciable because it is not ready to be rented out.

If so, you may be able to better time the tenant's arrival with the beginning of the depreciation deductions.

Basit Siddiqi · Answer

There are certain limitations of having expenses exceed income on a personal residence where it is a SFH and you are renting out the rooms.

Craig Janet · Answer

As others have mentioned, if you're doing a major reno you won't be able to deduct all of those expenses in the current year. They will have to be depreciated over the life of the improvements as defined by the IRS.

There are grey areas on what is considered a repair or improvement. But if it's a major reno project it will mostly likely have to be depreciated over many years.

David M. · Answer

@Theresa Harris

Pretty much same here.  Capital expenses before the unit is put into service is adjusted to the cost basis and thus becomes part of the depreciation.  Capital expenses after/while the unit is in service is depreciated per its schedule or deducted in the same year under de minimus rules.  Other repairs and the like are just expenses for that year.

But again, none of these go towards offsetting his w2 without jumping over some hurdles, if they apply.

Can Deductions Exceed Rental Income?

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