Expenses of rental properties increase the amount of tax owed

[avidinvestor]

I asked this question before but it got archived/deleted due to my inactivity on this site. I hope that I can get it answered (again) this time.

I have 2 rental properties. Both were rented for the entire 2018. Why does the amount of Federal tax owed increase when I add more expense deduction? There seems to be a "sweet spot" where I can get the lowest tax. If I increase or decrease the expenses, my Federal tax would go up.

[Carl]

Are you sure it's a "refund" amount going down? Confirm that it is "in fact" no5 the amount you owe to the IRS that is going down.

[avidinvestor]

It's the amount I owe (not refund) in Federal tax.

[Anita01]

Adding expenses lowers your Adjusted Gross Income.  There may be credits or deductions on your return that decrease as your AGI goes down.  For example, you need a certain amount of income to qualify for some credits.  As your AGI goes down, you may no longer qualify for that credit.  Keep in mind that lowering your expenses to allow for a bigger Eared Income Credit is not allowed.

People often don't realize that every entry causes an entire recalculation of your tax return and can often cause unexpected results.  The only way to tell what is really happening is to look at and, preferably, to print your 1040 before and after you enter a number.

You can look at your 1040 by clicking on Tax Tools on the left, then Tools.  Select View My Tax Summary, then Preview My 1040.

[avidinvestor]

Thank you. I'll preview the 1040 and do the comparison.

[Carl]

Do understand now, that since you acquired the loan 5-6 days before the in-service date, about 80% (give or take) of the interest paid in 2018 will be allocated to the SCH A. That's the way it works, and that's the way it's supposed to work. From my testing with my figures, if it's not spot on, then it will be close enough so as not to raise any flags with the IRS. I'm still bothered that you're not asked for a loan origination date though, and I am questioning this with the moderators.
From what I understand in IRS Publications 527 and 936, regardless of when you paid the interest during the tax year,(before or after conversion) it's prorated between the SCH A for the period of time it was personal use, and SCH E for the period of time it was business use. While the pubs do cover a refinance, they don't talk anything specific about your specific situation where you owned the property free and clear already, and "then" took out a mortgage, and "then" converted it to business use. So per the IRS Pubs, it would appear a prorating between SCH E and SCH A would be figured on the entire 12 months of the tax year. But my changing the business use percentage to 100%, it seems apparent to me that 3/12 of your total interest payments for 2018 (possibly a little bit more than that) are correctly being allocated to the SCH E.

[Anonymous]

It's probably because of the Qualified Business Income (QBI) deduction. You probably have carry-forward passive losses on your rentals. If you don't list rental expenses, the profit on your rentals increases, but you don't owe tax on these profits because of the carry-forward. Then you would get a QBI deduction of 20% of those profits. As you add expenses, the profit decreases, and the QBI deduction goes down, thus raising your taxes.

[bgauvin]

Thank you for this response.  This is what happened on my 2020 return after Turbo Tax neglected to carry forward my rental property asset.  I am glad they sent me an email, but I am not happy I just spent 2 hours wondering why adding more depreciation caused my refund to go DOWN.  Thank you!

[yim_h]

Hi 

I am not following, I have same issue of entering expenses increases my tax owe

please advise the steps that helped you to resolve the issue

[DawnC]

When you have EIC on your return, adding expenses can reduce your refund.   The tax benefit you receive from the rental or business deduction is less than your reduction in Earned Income Credit.   You have to take all eligible business and rental deductions if you are claiming the EIC. 

As stated in the other thread you commented in, the best solution to figure it out is to print out your tax return before you enter those deductions, then print it out again after you enter those deductions.  The look at which lines change on 1040 and the numbered Schedules (Schedule 1, Schedule 2, etc.).

If it still doesn't make sense, then post back with which lines changed on the 1040 and the numbered Schedules and somebody may be able to help you.  @yim_h