Interest income decreasing my paper losses

Atlanta, Georgia
Tax, SDIRAs & Cost Segregation
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Interest income decreasing my paper losses

Roger PearcePro Member
Rental Property Investor · Atlanta, GA · Member since 2016 · 29 posts · 7 votes

 I have 3 long term rental houses and I sometimes make loans to a local flipper. I am not a real estate professional - I have a real job! My tax guy keeps running the interest I make on the loans through my rental business, which eats up my paper losses. I have told him I would like to just run them through my personal taxes so that they won't use up my paper losses. He doesn't seem to understand that I am unnecessarily using up paper losses that are best saved to offset a passive profit later.

Am I missing something?

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Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
6mo

@Roger Pearce

It is not very clear what you're trying to accomplish that you believe is impeded.

Interest income is taxed at ordinary tax rates, the same as your W2 income. So your losses are offsetting your ordinary rate income - which is normally a good thing.

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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    6mo

    @Roger Pearce

    It is not very clear what you're trying to accomplish that you believe is impeded.

    Interest income is taxed at ordinary tax rates, the same as your W2 income. So your losses are offsetting your ordinary rate income - which is normally a good thing.

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  • Jason MalabuteBusiness Member
    Accountant · Los Angeles, CA · Member since 2016 · 2k+ posts · 898 votes
    6mo

    Interest income and rental losses are reported in completely separate areas of the tax return. Your rental property losses flow through Schedule E and are generally considered passive, while interest income is typically reported on Schedule B (or directly on the 1040) and is treated as portfolio income.

    Under the passive activity rules, passive losses from rentals generally cannot offset non-passive income. The two main exceptions are: (1) if you qualify as a real estate professional, which allows rental losses to be treated as non-passive, or (2) if your modified adjusted gross income is below $150,000, in which case you may qualify for up to a $25,000 special allowance (subject to phaseout).

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  • Roger PearcePro Member
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    Rental Property Investor · Atlanta, GA · Member since 2016 · 29 posts · 7 votes
    6mo

    Thanks guys 

    my accountant is adding my interest income to the income of my business, which decreases my paper losses. And yes, I pay taxes on that income as I should.

    If he were to add my interest income to ONLY my personal income then sure, I would still pay the taxes, but the income wouldn't have to decrease my paper losses. 

    Is that all correct? If so, why does he insist on putting that interest in my business taxes instead of my personal taxes?

    Michael, my business paper losses are not offsetting my ordinary income ever because my ordinary income is active (I am not a real estate professional and my rentals are long term) so my business is considered passive. If I make money from giving a loan, that is considered active so it would be smarter to leave it on the personal side. But my accountant puts it on the business side which leads my business paper losses to be eaten up by this active income that has nothing to do with my business

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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    6mo

    @Roger Pearce

    We do not have complete details, and it is tricky to guess because you're using some technical terms loosely and using some words that are not technical terms. And in taxes, it matters.

    Let's say you have:
    - $200k W2
    - $50k rental income
    - $70k rental expenses
    - $100k excess losses carried from prior year (I think this is what you call "paper losses" but should call "suspended passive activity losses")

    You have a current year rental loss of $20k which you cannot apply against your $200k W2 income. Result:
    - you pay taxes on $200k
    - you have carryforward passive losses of $120k pushed into next year

    Now we're adding $15k of interest income from your loans. You want to treat it similar to bank interest. Result:
    - you pay taxes on $215k
    - you have the same carryforward passive losses of $120k pushed into next year

    If this interest is "run through your rental business" (the technicality of how it is done is a separate conversation), the result would be:
    - you pay taxes on $200k
    - you have smaller carryforward passive losses of $105k pushed into next year

    Why would you want to pay more taxes today? In order to protect future losses? This does not make sense to me.

    And again, I'm not commenting on where this interest income actually belongs. Your accountant could be correct treating it as business income rather than personal portfolio income. 


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