Leftover Depreciation

Say I have an apt building that Nets 30k (NOI - Debt Service). Then come tax time, my depreciation claim is 75k. On returns, this would show a loss of 45k. What happens to that extra depreciation? Can it be carried over to the next tax year, and then year after year?

Your depreciation is taken in full each year your rental property is in service. The depreciation taken reduces your cost basis, dollar for dollar.

On your tax return in your example, the depreciation expense gave you a passive loss from your apartment rental activity. Now, if you have other passive income, you use this passive loss to offset other passive income. If you don’t have taxable income from any other passive activities, then you have a net passive loss from your rental activity. In your example, this net passive loss is $45K.

You are allowed to deduct $25K from your other ordinary income provided your income is not more than $100K. Between $100K and $150K of other income, your net passive loss allowance is phased out, becoming zero when your other income reaches $150K.

Any net passive loss that you can not use is suspended and carried forward to the next tax year, where it is first used to offset rental income, then income from other passive activities, then capital gains if the property is sold, then lastly, up to $25K of other ordinary income. Any net passive loss you still can not use, is suspended and carried forward to the next tax year, and the cycle repeats.

I see, so if I have LLC 1 and LLC 2, both own rental property, I can take the passive loss from LLC 1 and apply it to LLC 2 to reduce LLC 2’s taxable income? If this is the case, GOD BLESS AMERICA.

Additionally, can I use the passive loss from my real esate LLC to help reduce my taxable income from another LLC or company I own that is a different business than real esate? Thanks again in advance.

As a general rule yes. A more detailed discussion follows.

Maybe, maybe not. See the detailed discussion that follows.

I take it this is your first year as a rental property owner and you have not done a tax return yet that reports your rental property activities.

A rental property activity is a passive income activity. If you have made money after taking all your deductions, then you have passive income for the year. If your deductions are greater than your income for the year, then you have a passive loss for the year. Passive losses from your rental activity are first used to offset passive income from other passive activities.

If you have another LLC engaged in a business other than real estate, then it may not be a passive income activity. If it is an active income activity, then you can not use passive losses from your rental property activity to directly offset active income from your LLC.

Instead, you have to use the net passive loss rule. If your other ordinary income is $100K or less, then you can use up to $25K in net passive losses to offest other income on your 1040. For incomes between $100K and $150K, the net passive loss is phased out. If your other income is $150K or greater, then you can not use your net passive loss at all. In this instance, you suspend your net passive loss and carry it forward to the next tax year.

Got it, thanks. That makes sense. I have rental property now, that has a small loss at the end of the year which helps me with my work income taxes. But now I’m buying my first apt building, which should have a passive income loss because the depreciation is high. So if I continue to aquire larger and larger buildings with significant depreciation, I can essentially have tax free passive income until I have a passive income gain? This really is awesome. I knew about depreciation, but didn’t realize multi-families are treated just like SFH; 27.5 years depreciation. On multi-million dollar properties, this is a tremendouse advantage.

To add another twist…

If your depreciation is $75k, I would guess that this venture will be a full time job.

If you spend half your time in real estate, the $25,000 passive loss limit doesn’t apply.

mcwagner, what if I was managing rental property full time, but my income was over 100k. Could I still use the 25k passive loss deduction?

If you spend at least 750 hours AND >50% of your time in real estate, then you are considered a real estate professional. This removes the loss limitation and losses in excess of the $25k limit become deductible.