Small landlord exemption: always been $25K, up to $100K MAGI?

11 Replies

As the owner of a single rental property, I've been deducting rental losses every year, thanks to depreciation. I never thought much of it, because my W-2 income has always been well under the cap of $100,000 where it starts to get phased out, and the losses were nowhere near the limit of $25,000. 

But now I am creeping up to that MAGI level, and I need to be more careful about what I deduct, and whether it makes sense to increase 401(k) contributions to stay under that cap. Have $100,000 and $25,000 always been the numbers, or do they ever get adjusted for inflation, similar to the way the standard deduction, personal exemption, and 401(k) contribution limit seem to increase slightly most years?

Those have been the number for the last 10 years.  Your guess is as good as mine as to what they might be in the future.  Remember the taxes on the depreciation come due when you sell.  So, always better to think of the depreciation deduction as temporary delay of the taxes rather than a true tax deduction.

Originally posted by @Jon Holdman :

Those have been the number for the last 10 years.  Your guess is as good as mine as to what they might be in the future.  Remember the taxes on the depreciation come due when you sell.  So, always better to think of the depreciation deduction as temporary delay of the taxes rather than a true tax deduction.

Follow-up question: my understanding is that when my MAGI goes over $100K, I can still deduct the full losses, but the cap of $25K would decrease. My losses will be under $10,000. That means it's business as usual as long as my MAGI is less than $130K, right? 

This year I've been wary that I might lose my rental loss deduction, but after doing some homework and some math, I think I have a long way to go before it's an issue. 

That's correct.  The "special allowance" for being able to deduct passive losses (in which you actively participate, makes sense, eh?) gets reduced by $1 for every $2 of income over $100K.  So, a MAGI of $130K still leaves you a $10K special allowance.  

Hopefully you're buying deals that makes sense without this special allowance.  Sellers often use the ability to deduct depreciation against other income to slap some lipstick on a pig of a rental.  Because, this is very much a give with one hand, take with the other deal.

Originally posted by @Jon Holdman :

Hopefully you're buying deals that makes sense without this special allowance.  Sellers often use the ability to deduct depreciation against other income to slap some lipstick on a pig of a rental.  Because, this is very much a give with one hand, take with the other deal.

Absolutely. Everybody pitching real estate as a great investment talks about the various ways to make money (cash flow, appreciation, etc.), and the tax advantages invariably make the list, as they should. But buying property just for the tax benefits does not seem like a good strategy. I was a little too young to be paying attention, let along investing in real estate, but I read that the tax reforms that happened in 1986 were devastating to many real estate investors (i.e. those who invested primarily for the tax write-offs). Some have even argued it's responsible for a crash in the commercial real estate market. 

I'll fully admit my one rental property has not been a great investment (although the appreciation over the years has more than offset the poor cash flow). I'm holding onto it for personal reasons, and I still do treat it like a business (albeit a marginally profitable one) and take advantage of the tax benefits that are available. 

Now that I am focusing on syndications, all of my other real estate income is totally passive and needs to be considered separately from my solely-owned rental property. So I am not buying any more properties myself and have little chance of ever having rental losses that exceed the $25K cap. 

@Paul B.

Thanks for bringing this up,

I had never heard about this until now, and I am really bummed. I hear about depreciation all the time as an additional benefit for buy and hold, and although it's not the main reason for getting involved in cash flowing properties, it was definitely a big bonus for me. 

I am a big tax novice, but I want to make sure I understand this, 

My W2 is 140, and my wife's is 100. So this means we cannot deduct any depreciation unless we could get our combined AGI below 130k?  Is that 130k AGI limit for both spouses combined? Yikes.

Huge day wrecker! Wow. 

Can someone send me a link that explains this? Or spell it out? Are you saying that at a certain income level you cannot deduct deprecation from your income?

Hold on folks, my understanding is that you can always deduct depreciation (as long as you have depreciation to deduct). In fact, you really want to deduct it, because when you sell your property, the IRS is going to assume you took the deductions all this time, and your cost basis is going to be reduced by the amount that it assumes you depreciated. 

However, if you are showing a net loss, you can't deduct that loss against regular income unless your MAGI is under $100,000, and the loss you can deduct is capped at $25K. If your MAGI is $125K, you can deduct up to $12,500 in losses. If your MAGI is $150K and above, you can't deduct any of it. Also, you can only deduct losses against regular income if you are actively managing your property (no concrete definition, but you have to be the decision maker, not necessarily swinging a hammer) or you are a real estate professional (working over 750 hours a year in RE).

Example:

W-2 income $95,000

Rental property 

Rental income $13,000

Taxes $3,000

Maintenance $2,000

Mortgage interest $5,000

Depreciation $7,000

Rental loss that I report to the IRS on Schedule E: $-4,000 ($13,000-$3,000-$2,000-$5,000-$7,000)

So when I do my taxes, I get to tell the IRS I made $91,000 instead of $95,000. At a 25% tax bracket, that's an extra $1,000 in my pocket.

If I get a big raise and my W-2 income is now $120,000, I can still deduct those rental losses, but the cap of $25K gets reduced to $15,000 (it goes down by $1 for every $2 over $100K I make). I can still fully deduct my $4,000 loss, because it's under the $15,000 cap. If I had four of these properties, then I'm more likely to be up against the cap. 

As for depreciation, let's say I bought the property in 2007 for $200,000, and sold it in 2017 for $300,000. That's $100K in appreciation on which I will have to pay capital gains tax. But the IRS also assumes I took the $7,000 depreciation every year for the 10 years that I owned it. So I have to pay 25% income tax on that $70,000. It's known as depreciation recapture. 

I only got a grasp on this recently, so please point out my mistakes if there are any.