First, if you are renting at below FMRV, and especially if you are renting below FMRV to a family member, once your rental expense deductions get your taxable rental income to zero, that's it. Any remaining expenses are just lost, permanently and forever. This can really hurt if you were renting at FMRV before, say for 10 years and then rent to friend or family below FMRV. All those losses you've been carrying over the last 10 years are just gone, permanently and forever. Buh-bye!
Now understand that it is "extremely" rare for residential rental real estate to ever show a taxable profit "on paper" at tax filing time. Usually, when you add up your deductible mortgage interest, property insurance and property taxes and take the depreciation into account, your chances of showing a taxable profit are nil to non-existent. Then add to that your other allowed deductible expenses such as maintenance, repairs, etc. and you'r practically guaranteed to operate at a loss.
So once your deductible rental losses get your taxable rental income to zero, any remaining losses are carried forward to the next year. As the years pass, your carry over losses will continue to grow and accumulate. You don't get to "realize" those losses until the tax year you sell the property. In the tax year you sell, it works like this:
First, your total depreciation taken is added to your sales price (or deducted from your costs basis - either way gives the same end result).
Then your cost basis is subtracted from your sales price to determine your gain on the sale.
Next, all of your current year losses and carry over losses are subtracted from that gain to determine how much of the gain (if any) is taxable income.
If the taxable gain is zero and you still have losses to deduct, then those losses can be deducted from other "ordinary" income (such as W-2 income) at a maximum of $3000 per year until all those losses are used up.
