Could negative cash flow be deducted?

Question

Hi everyone,

I am about to become an investor renting out the condo I currently live in (Columbia/Ellicott City, MD area) and purchasing another house for my family. The condo was purchased in 2006 at it's highest ever price of $160K. Two weeks ago an appraiser came back with a bad news: it's only worth $80K and is underwater (despite all the renovations and updates).  So, refinancing is out of question for at least three-four years until we lower the balance to it's market value.

The plan is to still try to rent it. It could easily bring $1100/mo. Our PITI + condo fee is $1509. That creates a negative cash flow ($409/mo).

After all tax deductions (i.g. depreciation, interest, insurance, condo fees, local taxes etc.) the taxable income is $2,269. This number looks great except after accounting for negative cash flow of $4,908 the adjusted amount is now a loss $2639.

So, here's my question: can I deduct this amount as business loss?

Jon Holdman · Answer

@Nadiya Lonkevych  subtracting your net negative cash flow from the taxable income would result in subtracting a bunch of things twice and would result in deducting some non-deductible items.  I assume by cash flow you mean the rent you collect minus all the money you send out.  So, the deduction there includes interest on the loan, taxes, maintenance, etc. that are all deducted to get to the net taxable income.  If you then subtract the net cash flow, you've subtracted those things twice.  The bottom line from that arithmetic has no meaning.

Shaun Weekes · Answer

Hello Nadiya,

Check to see if your property is owned or serviced by Fannie Mae or Freddie Mac.  You can do this by going to the following websites

https://knowyouroptions.com/loanlookup ( Fannie Mae )

https://ww3.freddiemac.com/corporate/   ( Freddie Mac )

If your loans is owned or operated by either of these companies you might be able to refinace under DU Refi Plus ( Fannie ) LP Open Access ( Freddie Mac )  The programs are made specifically for people in your situation.

I hope this helps and let me know how it goes and if you need any additional help.

Nadiya Lonkevych · Answer

@Jon Holdman

Thanks for your quick response. I will definitely use an accountant for my taxes once we rent this condo out. It is way over my head at this point, since I have no prior experience. And yes, I was strictly talking about cash flow, not net negative taxable income.

Pawan W. · Answer

@Nadiya Lonkevych I have a condo and going through similar financing voes.

I wont mind getting on a call to share my experience, I just met a local lender who might be able to help you.

Jon Holdman · Answer

Sorry @Nadiya Lonkevych but I don't understand what you're saying.  I think you may be mixing up taxable income (what's on schedule E) and cash flow (the net money in your pocket.)  The IRS only cares about taxable income.

On schedule E you will put down the income you actually received, the actual expenses and depreciation.  Depreciation is a deduction from the income, but not an actual cash-out-the-door expense.  The principal part of your debt service payment, OTOH, is cash out the door, but not a deductible expense.  In addition, many of the up front expenses may have created a large year one loss that ends up carrying forward.  So cash flow and taxable income are very often different numbers.  Cash flow is absolute irrelevant for taxes.

If you mean you have ended up with a negative net taxable income on Schedule E then you may be able to use that to offset other income.  If your AGI is under $100K then you are allowed a special exemption of up to $25K in passive losses to use to offset other income.  If your AGI is over $100K this special exemption is reduced by $1 for every $2 of AGI over $100K.  So, if your AGI is over $150K you cannot use passive losses to offset other income.

There is a way to do this if your are a RE professional.  That means you spend at least 750 hours per year doing real estate work AND you spend more hours on RE than anything else.  If you have a full time job, you would need to spend 2081 hours a year doing RE.  So, unless you're full time investor, agent or some such this probably doesn't apply.

If you can't take the passive losses they carry forward and can be applied when you sell.  This is important because as you take depreciation (or are allowed to take it even if you don't) the basis for your property decreases.  This increases your gain when you sell and these passive losses help reduce that.

If you're not using an accountant for your taxes I think you're making a serious error.  This stuff is very complex.  If you understand it thoroughly you might get away with turbotax to fill out the forms.  If you don't I don't think you get an accurate return doing it yourself.

Nadiya Lonkevych · Answer

p.s. Refinancing to 30 years instead of 15 (that what the mortgage currently is) would help actually creating positive cash flow of $50/mo but like I said in the previous post it's out of question because of the equity issue.