Depreciation still possible?

Question

I am looking to buy a rental property turnkey. I understand some tax benefits should be money I used on maintenance and the mortgage, but the biggest one depreciation seems to be out of reach.

Do most people still use depreciation as a tax deduction? Are you satisfying the requirements which I believe are actively working in real estate for 750 hours? Can you argue that even though you hired a property manager, you are still delegating responsibility and monitoring activity and therefore you are actively involved?

What about the 25k write off in passive losses?

What about deducting for a "home office" even though you have a property manager?

Dave Toelkes · Answer

1.  A taxpayer with real estate professional status is able to deduct all net passive loss from residential rental activities without regard to the $25K net passive loss limitation or the high income phase out rule.  To qualify for Real Estate Professional status, the taxpayer must spend at least 750 hours in a real estate related activity AND at least 50% of all personal service activity must be in the real estate activity.  In addition, the taxpayer must be an owner or a part owner of the real estate activity AND must meet material participation rules.  As a general rule, the 50% rule virtually eliminates anyone with a full time W-2 job from qualifying as a real estate professional.

2. The net passive loss is reduced by $1 for every $2 of income over $100K.  The net passive loss allowance is $0 at $150K MAGI and above.

Paul Strauss · Answer

https://www.irs.gov/pub/irs-pdf/p527.pdf

Dave Toelkes · Answer

@Kyle Scholnick

Perhaps I can help clear up your questions.

1.  There is no 750 hour rule with regards to depreciation.  There is a 750 hour rule to qualify for Real Estate Professional status.  Two completely and mutually exclusive concepts.  You can take the depreciation deduction for your rental property even if you don't have Real Estate Professional status.

2.  Depreciation must be deducted.  When you sell the property, the IRS will still tax you on the depreciation you should have taken, but didn't -- so take the depreciation deduction.

3.  There is no income requirement or limit for the depreciation expense deduction. Depreciation is deducted from your rental income.  If taking the depreciation deduction gives you a net rental loss on paper, you can use your rental losses (up to $25K) to shelter your other ordinary income from taxes.  This passive loss allowance is phased out if your modified adjusted gross income is above $100K and disappears completely at $150K and above.

Chris Soignier · Answer

You don't need to be a real estate professional to claim depreciation, only to claim passive losses beyond the threshold that applies to others.

Even though I work out of my home, I don't claim a home office deduction, since it seems to be an audit trigger, and I don't want to expose myself to that much hassle.

Dave Toelkes · Answer

If you meant to say real estate professional status, then yes, you are correct.

Kyle Scholnick · Answer

@Dave Toelkes

So as long as you aren't filing for any loss over $25k, the whole real estate participation thing doesn't really matter?

Kyle Scholnick · Answer

@Dave Toelkes

Thanks Dave, that's helpful, so then what is the 750 hour do? What is the benefit or downfall of qualifying as a real estate professional or not? What does that effect?

Regarding passive loss and the MAGI requirements, how do you calculate how much losses you can use if you are within that income range?

For example, if someone makes 130k, how do you figure out how much passive loss you are allowed to take?

Kyle Scholnick · Answer

@Brandon Hall

To make sure I am clear on what you're saying:

The 750 hour rule is just related to passive losses and NOT depreciation? I can still deduct for depreciation even though I am not covering the 750 hour rule?

If that is the case, are you saying that once my depreciation is factored in and I come out to a paper loss, I can't deduct that loss?

Are there any restrictions on filing for depreciation? Do I need to meet certain income requirements or anything else?

Brandon Hall · Answer

@Kyle Scholnick a lot of questions here. There is too much to discuss and too many variables for a simple forum post. I recommend you contact a CPA and have a consult.

You MUST take depreciation on your rentals, it is not an option. If you are phased out of taking passive activity losses (PAL) then your loss simply carried over into future years until it is used or you sell the property.

The 750 hour rule relates to being classified as a real estate professional for tax purposes. You must work in a real estate trade or business (does not have to be rentals) for 750 hours and greater than 50% of all your working hours in the year need to be in that real estate trade or business.

Once you satisfy those requirements, to deduct your passive losses from rental activities you must then satisfy materiality requirements, generally 500 hours spent working on your rental(s). Only then will you be allowed to take a passive loss you were otherwise phased out of.

You can have a home office as long as you use it regularly and exclusively for your rentals. Believe it or not, if an IRA auditor walks through your home to view your home office and they see books on your home office's bookshelf not related to rental properties, they will disallow the deduction.

Depreciation still possible?

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