The Government Accountability Office reported that 53% of taxpayers with rental real estate misreport when they file their tax returns. That means many property owners overestimated real estate tax loss. The bottom line is that owning rental real estate is now an audit flag. These inflated tax losses. The IRS exception allows a deduction for rental expenses and losses that exceed the rental income, up to $25,000. However, active participation requires that your rental properties require a significant amount of your time to make management decisions, screen prospective tenants or provide services to tenants, such as daily linen and cleaning. Applying the Loss to Other Properties and Your 1040. If you have a loss, you almost always can use it to offset income from other properties. If you meet the IRS' narrow definition of a real. For example, if your adjusted gross income is $125,000, you can write off $12,500 in rental losses in the year of the loss. If you are an active participant and your adjusted gross income is $150,000 or more, y ou can write off no rental losses on your tax return in the year of the loss.

Home owners renting out their property and real estate investors alike are often faced with a unique dilemma in financial difficulties: should they continue to manage their properties or simply sell them at a loss?

But that dilemma becomes even more pertinent if the property in question is a rental property. For one, some think that rentals are supposed to be a fool-proof investment. At least, in theory. But there’s an entire host of potential issues homeowners have to confront with a rental property. Screening tenants. Leases. Property maintenance. Even the threat of having to legally evict a tenant. Sometimes, it can be more hassle than it’s actually worth.

Especially if you’re in a down market. But the sale of rental property at a loss isn’t just about losing an investment or your legal liabilities as a homeowner. There’s also some advantages to selling rental property at a loss: tax implications, to be more precise.

When Is Selling Rental Property Actually A Loss?

Whether or not a rental property is viewed as a tax gain or a tax loss is generally based on three specific factors:

• Your initial investment when you first purchased your home.
• The cost of any improvements or renovations you may have made.
• Any depreciation deductions you’re claiming on your income taxes.

If the cost of your deductions exceed that actual cost of your improvements and the value of your home has actually depreciated, it’s claimable as a Section 1231 tax loss as business property—provided you’ve held the property for at least a year. There’s one exception to this: a like-kind exchange.

A Section 1031 like-kind exchange occurs when you acquire one property of equal value in exchange, typically for tax deferral purposes. However, if the property you received in a like-kind exchange happens to be the rental property you plan on selling, IRS law requires you to transfer your existing tax basis to the new property, And if your tax basis is actually larger than the loss you’re claiming, it will be considered a tax gain.

Why Should You Claim Rental Property As A Tax Loss?

Claiming rental property on your income taxes can be considered business property, even if you’re not officially registered as a small business in the state of Utah. This allows you to include not only any losses you may have incurred from the depreciation of your home value, but also necessary home repairs, insurance, loan interest and even the cost of new appliances.

What’s more, if the loss you’re reporting is large enough to reduce your income to zero for two years or more, you can actually qualify your rental property as a net operating loss. You can recover most of your previous years losses simply by amending your returns to offset the previous taxable income for those years and ultimately ease the burden of selling your rental property.

Note that eligibility for claiming a loss on your home is waived if the property depreciated in value prior to converting it to a rental property.

Can I Claim My Personal Residence As Rental Property?

Irs Loss From Rental Property Income Calculator

Converting a property from a rental back to your primary residence disposes you of your right to claim it as an income source and subsequently cannot be claimed as a section 1231 tax loss. However, you may be able to escape taxation of up to $250,000 ($500,000 for certain married couples filing joint returns) of gain on the sale of your home if you’ve used your residence for at least two out of five years preceding the sale of your home.

Fair Market Value And Selling Your Rental Property

If you’re selling your rental property at a gain the tax basis consists of the original cost plus any amounts paid for improvements (not repairs), minus your depreciation deduction. If you’re selling your rental property at a loss, however, the starting point for the basis is the remainder of the value of your property at the time it was converted from personal to rental property. You may, however, be eligible for a $250,000 tax gain exclusion if you’ve rented your property for three years or less prior to its sale. Speak with a trusted tax professional for more information.

What If I Need To Sell My Rental Property Immediately?

It’s actually a fairly common practice to sell a rental property at short notice in Utah, even if you still have tenants with an active lease agreement. Utah law requires at least a 15 day notice to vacate if there is no set end date contained in a tenant-at-will lease, or a 5 day notice of tenancy at will if there is no rental agreement or if one has expired and you don’t plan on renewing.

But if you’re trying to sell a rental property at a loss only to discover your tax basis is larger than you expected, it might take you well over three months to find a qualified buyer. In the meantime? You still have to deal with no small share of headaches as a landlord. If you’re looking to sell your home immediately in Utah, why not ask us for help at Gary Buys Houses? We’ve been helping rental property owners get the best estimate for their properties quickly, conveniently and fairly. We’ll even help you find a qualified tax professional to help you claim the optimal deductions on your return!

Sometimes, rental properties are unquestionably fool proof. Other times, you really aren’t certain what you’ll get into until it happens. Like everything in life, it all depends on circumstances. Just keep in mind that a loss can sometimes be more of an advantage than you could have ever expected.

Surely you didn’t buy your second property with the hope or expectation that it would decline in value. Real estate markets fluctuate, however, and the U.S. economy has not been kind to property investments in many parts of the country. After years of renting our your second property, perhaps you’re coming to realize that its value is significantly less than the purchase price. The good news is that you might be able to turn lemons into lemonade in the form of tax benefits.

Ordinary Income Tax vs. Capital Gains Tax

In case you don’t have much grounding in tax law, a few definitions will help you navigate the implications of your rental property sale. First, there are two broad categories of deductions to keep in mind: ordinary income tax deductions and capital gains tax deductions.

Ordinary income is, generally speaking, your wages and basic interest income – the main items that most taxpayers need to report on their IRS 1040 every April. Capital gains result from selling a capital asset, such as a stock, for more than its purchase price, or basis. Capital gains are taxed at lower rates than ordinary income, and are reported on Schedule D of the 1040.

Irs Rental Income 1040

Although profit on selling a rental property might have to be reported as capital gains, losses when selling rental property are deductible from your ordinary income. Learn more about the different types of taxable income on the Internal Revenue Service (IRS) website on “Capital Gains and Losses.”

Using Your Tax Basis to Calculate Your Loss

Irs Rental Loss Limitation

The first step in calculating your loss is figuring out your property’s “tax basis,” which you will later compare to your property’s sale price.

To determine your tax basis, add the amount you purchased your property for, plus any improvements (for example, renovations or additions, but not repairs) that you haven’t previously deducted from your taxes. These deductions include closing costs, such as legal fees and title insurance. Next, subtract any depreciation deductions that you’ve previously taken.

Irs Loss From Rental Property Income Limits

As an example, let’s say you bought a property for $200,000 and made $10,000 in upgrades. This gives you a $210,000 tax basis. But you’re in a rough real estate market, and need to sell for $100,000 – a huge loss. In fact, when you subtract your tax basis from your sales price, you find that your loss totals $110,000, for tax purposes. That loss may be deductible.

No Deduction Allowed for Sale of Primary Residence

Importantly, the U.S. tax code does not allow deductions of losses for your residence, that is, the home you actually lived in – only for sale of investment-related property. As long as you’ve categorized your rental property as such, you should be able to take advantage of this benefit.

Converting Personal Residence to Rental Property for Purposes of Deducting Losses

Although you may think that you can get around the personal-residence rule (described above) by simply converting your home into a rental property before selling, this only works to a point. The U.S. government will not allow you to deduct losses in value from the time period before the rental conversion.

In other words, if you lived on the property before you officially began reporting it to the IRS as a “rental property,” and the house declined in value before the conversion, this might not be considered a tax loss. However, a loss from a decline in value after conversion to a rental is likely deductible.

Getting Professional Help May Be Worth the Cost

Irs Rental Income Worksheet

As you can appreciate, the nuances of these sales can be complex. Some are outlined on the IRS website on“Business or Rental Use of Home.” Make sure to consult an accountant or tax attorney and to figure out the tax basis of your property before you sell. This is a situation where “do it yourself” can be mostly if done incorrectly. The upfront cost of a professional consultation is far less than the risk of an audit of what will be a substantial sum of money.