Can Carried Forward Losses apply against Recapture or only Gain

General Real Estate Investing
1

I am thinking about buying a rental property, but my modified AGI is over $150,000. This means that I can’t get the huge benefit of claiming up to $25,000 each year in losses against my ordinary income.

Any losses can apparently be carried forward each year, until ultimately I sell the property. My question is, against which part of the asset sale can I count the carried losses against? Can I count them against the depreciation recapture part, the capital gain part, or both?

2

ooh, good question. I know the carried loss can be used to offset the cap gain… offsetting against the recapture will take some research.

Dave or Steve may know offhand.

3

If your only passive income activity is a rental property operation in which you actively participate, then a prior year suspended passive loss is used in a specific sequence as follows:

  1. To offset current rental income
  2. As an adjustment to basis (addition) if the property is sold
  3. As a passive loss allowance against other ordinary income if otherwise allowed

If after all these opportunities, you still have an unused passive loss for the current year, then it is again suspended and carried forward.

If the property is sold, suspended passive losses are added to your adjusted cost basis, which has the net effect of reducing the taxable capital gain including the amount of unrecaptured depreciation subject to tax.

4

Thanks for your responses. I just had one more question - I read something on the instructions for the IRS form Sale of a Business Property that mentioned adding up the losses from the previous five years.

Do you know if you’re limited to carrying forward a loss for only 5 years? Or can you carry one forward for the whole time you own the property, if you never make any money on it?

5

I agree with Dave T.

I think the five year thing is, er, well, just plain wrong.

I wonder…You may be thinking of actual net operating loss carryforwards and carrybacks (which at very times have been carried back five years but not currently).

Note that the losses we’re talking about are actually passive suspended losses. Essentially, they get unlocked with you have passive income or when you sell the property.

Also, just to be really darn nitpicky, there’s not really recapture of depreciation in a technical tax law sense. Recapture refers to, er, “recapture” of depreciation taken in excess of straightline depreciation. Here we’re presumably talking about, gulp, “recapture” of straightline depreciation which is technically unrecaptured Sec. 1250 gain. (Sorry.)

6

yeah. what they said.

while Dave was answering your question, I was working down through the various forms to see exactly where everything pops out.

all that loss eventually ends up on the front of the 1040 where it will offset any additional income (W-2, etc) once the property is sold. So it offsets both the cap gain and recapture as well as any other income you have.