In prior articles we discussed the tax deferral benefits of real estate, including depreciation and cost segregation. One question we are frequently asked is how such paper loss is treated and whether it can offset one’s active income.
As usual the answer is – it depends. And as usual, please consult with your CPA or tax advisor as the below snippet is not intended to serve as tax advice.
For those that are actively participating in the management of real estate, i.e. making management decisions such as lease renewal terms, tenant approvals, expense approvals, etc., the IRS has certain provisions. Specifically, if one makes below $100,000 in annual adjusted gross income (AGI), you can use up to $25,000 of passive losses to offset against the active income. Such allowance phases out at 50% up to AGI of $150,000 and above $150,000 it completely phases out.
For example, if you make up to $90,000 in AGI, you could apply the full $25,000 against the W2 income. If your income is $125,000, then you can offset up to $12,500 [=$25,000-(($125,000-$100,000)*50%)]. And at $150,000, it is $0.
What happens if you do not have a rental portfolio or are not involved in the management decisions and are truly passive? You do NOT lose such passive loses. Instead you can either carry them forward to offset the capital gain and depreciation recapture at the time of sale OR you can apply them to offset other passive income.
Many people apply this strategy when they implement what is known as a “lazy 1031 exchange”, i.e. in the year when they record a gain from the sale of a syndicated property, they enter into another syndication expected to perform cost segregation and thereby record a large paper loss in the same tax year. Thus, the tax loss in year 1 of the new syndication offsets (partially or fully) the gain recorded from the prior syndication.
When investing in multifamily, where the property size is larger, such paper losses can be pretty meaningful (especially if your ownership share is larger). Such tax deferral and tax savings can be potentially used to invest in other cash flowing investments thereby augmenting one’s income stream and net worth over time … step by step, year over year… Time does wonders in real estate, if one is patient.
Should you have any questions or want to learn more about real estate investing or for an overview of our target markets, please reach out to info@dbacapitalgroup.com.
Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.