Why can’t I deduct the renovation costs for a rental apartment?

[Bruce F]

My spouse and I are privately employed and not in real estate business. We have a rental unit that almost breaks even every year after all costs and depreciation (e.g. +/- $3,000). We spent $12,000 for renovation costs last year installing new windows and doors. But, when I enter that in Turbotax under repairs it doesn’t make much difference to our bottomline taxes owed! What is the maximum amount allowed for renovations deduction every year, and what is the best way to deduct them?

[JohnB5677]

It may depend on your income.  There is a limitation on passive losses.

Under the passive activity rules, you can deduct up to $25,000 in passive losses against your ordinary income (W-2 wages) if your modified adjusted gross income (MAGI) is $100,000 or less.

[Bruce F]

Thanks, John. What’s the best way to account for rental property renovation expenses if MAGI is more than $100K?

[DawnC · Accepted solution]

Ah, there's a big difference between improvements and repairs. The cost of property improvements  generally must be capitalized and depreciated over several years (by following IRS depreciation tables) rather than deducted in the year paid.   By contrast, the cost of repairs can be written off in the year you pay them. 

Most rental properties create losses, but since rental income is passive, the losses created by rental properties are passive losses.   You can only offset passive losses from other passive income.   The losses will accumulate until you sell or otherwise dispose of the property or have passive income.   Until then, all of the losses are suspended.  

As John mentions above, there is a $25000 exclusion, but if your MAGI is over $150K, you can't use it.   The exception phases out as your income rises.

• If you have modified Adjusted Gross Income over $100,000, the $25,000 rental real estate exception decreases by $0.50 for every dollar over $100,000.
• The exception is completely phased out when your modified adjusted gross income reaches $150,000.

Enter your repairs and depreciation for the improvements.   The loss will carry over to future years on Form 8582.   Once you have passive income or you sell the property, you can use the losses.  But they won't make any $$ difference on this tax return.    

[Bruce F]

Thank you, Dawn! Looks like if I check Box G on Schedule E Worksheet, TurboTax lets me deduct all my rental properties losses this year.  This is more desirable! What are the criteria to check Box G (Other Passive Exceptions) on Schedule E Worksheet to be able to use this feature? I could not find Box G explained anywhere. 

[JulieS]

Box G is for other passive exceptions. Based on your earlier posts, you should not check box G. 

This refers to the  two exceptions that allow taxpayers to use passive losses to offset earned income:

• The passive loss allowance which allows taxpayers with a Modified Adjusted Gross Income (MAGI) of less than $100,000 to deduct up to $25,000 of passive losses against their other income. 
• Qualifying as a Real estate professional.

Since you indicated your income was too high, you could only meet the real estate professional standard, which is:

1. More than one-half of the personal services performed in trades or businesses by the taxpayer during the tax year are performed in real property trades or businesses in which the taxpayer materially participates, and
2. The taxpayer performs more than 750 hours of services during the tax year in real property trades or businesses in which the taxpayer materially participates.