Depreciation when expenses already exceed rental income

[myusername777]

This year my rental property expenses exceed the rental income.  Taking the depreciation for this year only increases the loss (which I cannot claim on my taxes anyway).  Would there be an advantage to not taking depreciation for this year?  Would this affect the recapture of depreciation when I sell the house?

[leeloo]

No, this will not help you at all. You will still have to recapture the amount, whether you the depreciation or not. By taking all your expenses, you may be able to rack up some passive loss dollars to help you out at the time of sale. Any losses you take now count against your other income. 

[Carl]

It is perfectly normal for long term residential rental real estate to show a loss each and every year. In fact, it's not all that normal for rentals to show a profit. But it does happen due to some changes in the law in 2018.

When your rental losses exceed your rental income, once they get the taxable rental income to zero, any remaining loss is just carried over to the next year, where it can be deducted *if* you have the rental income to deduct it from.

With each passing year your passive activity loss (PAL) carry over will increase. But in the year you sell the property, all those carry over losses can be realized and deducted in full (with possible limits).

First, those losses are deducted from any capital gain you may realize on the sale. If it gets your taxable gain to zero, the remaining amount of loss is deducted from any other ordinary income, such as W-2 income. If there's still more loss (not all that common) then it gets carried over to the next year where it can be claimed (with limits) against other ordinary income.

Not taking depreciation will hurt, more than help. If you don't depreciate the property, then in the tax year you sell or otherwise dispose of the property, you are still required to recapture and pay tax on the depreciation you *should* have taken. So for you, it's lose-lose any way you look at it.

[SharonD007]

No, there is no advantage to not claiming your depreciation on your rental real estate, it is a disadvantage, and it will affect the recapture of your depreciation when you sell. You are not legally required to depreciate your rental property but if you do not depreciate your rental property, you are losing a portion of your profits. If you sell the property, the recapture of your depreciation (even if you did not take it) is taxed up to 25%.

Since rental property activities are passive, there is a limit to the amount of the passive losses that can offset your income. If you are an active participant in your rental activity you can deduct up to $25,000 of your rental loss. There are two requirements to determine if you actively participate in your rental property activities which are:

• You own at least 10% of the property
• You make major management decisions: making rental terms, deciding new tenants, and approving improvements.

If the amount of your passive losses exceeds the amount that you can report on your tax return, it will be carried over into the next year(s) until you have a profit and can be deducted from your profit.

Please review the TurboTax article Rental Real Estate and Taxes for further information.

[myusername777]

Thank you for your detailed, helpful, reply.  Does TurboTax handle the PAL and tracking from previous years (done with TurboTax)?  Or, would you recommend contacting a tax professional?

[PatriciaV]

Yes, TurboTax tracks your passive losses year-to-year, as long as you prepare your returns with TurboTax. 

The PAL carryovers are reported on the Schedule E Worksheet for your rental properties, after the QBI section. This is a TurboTax worksheet, not an IRS form.

Form 8582 Passive Activity Loss Limitations is included with your filed tax return each year and shows how your carryover losses are applied.

[Carl]

Does TurboTax handle the PAL and tracking from previous years (done with TurboTax)?

For the most part, yes. But you should still check and confirm. Any PAL carry overs will be on IRS Form 8582.

With the tax law changes in 2018, if you qualify (and a fair number do qualify) then up to a maximum of $25K of the excess passive losses can be deducted from other ordinary income. So it's possible for one to not have carry over losses. It just depends on the numbers.

I know for me I had PAL carry overs until around 2019 or 2020. Starting in 2018 I was able to deduct an additional $25K against other ordinary income, because I met the requirements to do so each year. I think 2020 was the last year I had carry overs, and they were all used up against other ordinary income. Since then, I've not had any PAL carry overs to deal with. But with rising property taxes and insurance, that could easily change in the future.