Passive Loss Carry Over Reduce IRA distributions

[Carl Graff]

OK just found out we (my wife and I) have about 65K in passive loss carry over going forward. So being retired with 2 rental incomes that break even or only generate a little income we will not be able to apply much if any of this for the foreseeable future. 

So one way to to benefit from the carry over is that we can apply 25K per year to ordinary income. Ironically I have visited web sites where licensed CPA's explicitly contradict each other over such a basic question as to weather you can use passive loss carry overs to reduce ordinary income. I believe, after several hours of research on the internet, the answer is yes you can use passive loss carryover to offset up to 25K of ordinary income *IF* you make less than 100K (which my wife and myself do as we only have a household income of about 40K per year - mostly from social security).

So assuming the above is true I think we can take withdrawals from our IRA's up to the amount where we have an excess of 25K extra ordinary income and than the carry over loss could then be used as a deduction against this income. 

Since I cannot find a clear answer to this - am I correct that IRA distributions count as ordinary (taxable) income and therefore we can use up to 25K per year of the passive carry over loss to reduce the tax liability incurred from the IRA distributions by that 25K amount?

I am really curious if the CPA's that reply (if any) to this are all in agreement. Because I will use a tax advisor - but due to the conflicting responses in blogs on this matter I just want to make sure that I choose one that agrees with the advice I get here.

Thanks,

  Carl

[Carl Fischer]

@Carl Graff

Great question and thought. Ira distributions are taxed unless they are Roth accounts. If it turns out to be true I would consider using for a distribution or a conversion to a Roth.  I would also start with your own cpa that knows your specific situation. 

@Michael Plaks @Lance Lvovsky @Ashish Acharya, @Brandon Hall usually have good answers and also challenge each other when complex issues are involved. Hopefully they will chime in. Keeping in mind 2018 changes. 

[Michael Plaks]

@Carl Graff

The answer is simple: yes you can, and probably even should.

Reason: when your income is that low, your carryforward losses will likely end up partially wasted each year until depleted completely, with no real benefit to you.

But, like any tax advice, this is generic, and it can be wrong for various specific circumstances.

And I have a suggestion. Why use a tax advisor who agrees with the tax experts on this forum? Why just not use one of us?

[Carl Graff]

Thank you Michael.

I don't want to arbitrarily choose a tax advisor because of the many conflicting responses by CPA's and tax advisors on this topic. So as in any profession not all tax advisors seem equally qualified and truthfully some replied that this was NOT the case and therefore a client might not be getting the best possible advice depending on who they choose.

I will do early planning for my 2018 tax return so I will have a real good idea of just how much money I should take out as IRA distributions. I will be getting my extension tax returns back for 2017 next week and can start this early planning process based on them.

[Daniel Dietz]

@Carl Graff from a layman's perspective, I think you are on the right train of thought. @Michael Plaks has an excellent thought that this could *maybe* be a good time to do some ROTH conversions. I also strongly agree with his thoughts of using service providers that I have found here on BP. I have had nothing but good results with those I have used. Im my mind, they all seem to 'get it' more as to the whole processes we go through in the real estate field. 

Just out of curiosity, is most of your loses from rental depreciation? I have a potential private money partner for rentals who is very interested in maximizing 'his tax loses'.

Dan Dietz

[Carl Graff]

Yes it is mostly from depreciation, but also as a result of repairs and maintenance eating up profit - which could be deferred but at the risk of deteriorating the properties. Pretty sure I don't need to do traditional IRA conversion to Roth to take advantage of this because simple distributions from a traditional IRA count as ordinary income - but this is where some of the confusion starts to pop up. It may be advantageous to convert some or all of my Traditional IRA to Roth but I don't think it is necessary to do that in order to get the $25K per year passive loss carry over deduction. This is why I am glad we have a forum to discuss these things and hopefully this thread will be useful to others.

Thanks,

  Carl

[Daniel Dietz]

@Carl Graff it is a lot to wrap your head around, isn't it? 

I just read a GREAT book dealing with IRAs called "Keep It!". It was recommended by one of the SDIRA providers here  and has AWESOME examples of when conversion *might* make sense that are not always thought of. 

I *think* what @Michael Plaks was referring to with the 'conversions' is if your passive loses are say 65K and you can offset them with 65K of ordinary income, which IRA withdrawls or conversions are, it *might* make sense to do the whole 65K, and then decide how much you 'need to use' (withdrawl) and convert the rest. That way, all future earnings on the ROTH funds would be tax free.

Dan Dietz

[Michael Plaks]

@Daniel Dietz

I was not talking about a Roth conversion - it was @Carl Fischer who mentioned it.

Both distributions and Roth conversions are taxable the same way. Normally, there's a 10% penalty issue that separates the two, however not in this case, since Carl Graff is in the retirement zone already. There could be reasons to convert rather than distribute, but it's a matter of an overall financial planning.

You're correct that my point was - yes, it might make good sense to use up the entire $65k in one strike. No point to save it for future capital gains, because Carl is likely in the $0 capital gain bracket. However, $65k is not possible in one year, making tax planning essential.

Once again - tax planning needs to be discussed one on one, in more detail.

[Michael Plaks]

@Carl Graff

The CPAs you're referring to did not necessarily contradict each other. The answer could be yes or no, depending on the context. It's possible that they were talking about a different set of circumstances. 

Of course, it's also possible some of them were wrong - happens in every profession, including ours. And this is why I advocated using experts from our BiggerPockets community. Our strength is that we specialize in real estate, and the $25k rule (actually, an exception to a general rule) is one of the niche rules. General CPAs may not be aware of them.

[Carl Fischer]

@Michael Plaks

😄 Oh how I wish I was in the $0 capital gains bracket-but i am working on it. 

[Michael Plaks]

Originally posted by @Carl Fischer:

@Michael Plaks

😄 Oh how I wish I was in the $0 capital gains bracket-but i am working on it. 

 Entirely your own fault! :)

[Account Closed]

@Michael Plaks gave some great answers. @Carl Graff if you pull up Form 8582 you will see that in Part I Line 1c your prior year losses (65k) will populate and will be summed on 1d. So, for this scenario lets say 1d also sums to a loss of (65k). 

Assuming you have no other activities you will carry the amount from line 1d to Part II Line 5 (Special Allowance section). This section is where you will be allowed to burn through some of that carryover because of your current year income falling. Hopefully, this helps and eyes did not glaze over by filling out a worksheet:)

Obviously, the above is a simplified and stripped down answer and your full picture can dramatically change the above answer. I just wanted to prove out for you how prior year losses can be released by your overall income falling under the threshold. You will definitely want to hire a CPA or someone well versed in real estate tax. Looks like you might have a consensus so far!

[Carl Graff]

@Account Closed Thanks - that's the most explicit advice I've seen. Nope my eyes did not glaze over as I've created very complex business intelligence and  financial reports in various IT roles over the years. That being said, I agree it's best to work with a CPA or someone well versed in real estate tax to help with my planning because you never know what you don't know.

[Account Closed]

@Carl Graff Great! Also, walking through the form shows you that you do not carry over the 25k special allowance each year. It's a 25k max that's available each year provided your income is under the threshold and you have losses to use. 

[Carl Graff]

@Account Closed So just so I understand correctly the 25K is not a once in  lifetime deduction but rather can be used any year you have a passive loss carryover and an income under 100K. 

So for example (disregarding additional losses or income from properties in future years):

Tax Year 2018, Passive Loss CarryOver 65K, Income < 100K, Take 25K special deduction, Remaining Loss CarryOver = 40K

Tax Year 2019, Passive Loss Carry Over 40K, Income < 100K, Take 25K special deduction, Remaining Loss CarryOver= 15K

Tax Year 2020, Passive Loss Carry Over 15K, Income < 100K, Take 15K special deduction, Remaining Loss CarryOver= 0K

Is this correct?

[Account Closed]

@Carl Graff Yes. Assuming the facts of simplified example.