The ownership of a residential rental property by a couple or individual is subject to various IRS rules that describe the tax implications of renting the property. Losses related to the asset’s decrease in value are deferred until the property is sold and the loss is considered realized. Other losses on rental property can offset other types of revenue from passive activities, where income is earned for the use of the property and not for a service rendered. Generally, losses from passive activities are limited and subject to at-risk provisions.
Residential Rental Property
Your residential rental property earns revenue and incurs expenses that must be disclosed for tax purposes. Rental income consists of any payments you receive for the use or occupation of the property. Types of rental income include advance rent payments, payments to cancel a lease, expenses paid by the tenant, security deposits, and any property or service received in place of a rent payment. Rental expenses include maintenance, depreciation, insurance, taxes and interest; these are deducted from rental income. If your total rental expenses exceed your rental income, you have incurred a loss on your rental property.
Passive Activity Limits
One set of rules limiting the amounts of rental property activity losses that can be deducted are passive activity limits. The IRS regards most rental property activities as passive, which means that the income received is mostly for the use of the property and not for a service rendered. So, losses from passive activities can only offset passive activity income. Any excess loss is carried forward to the following tax year. Exceptions to these rules may apply if you are a real estate professional or engaged in a real property trade or business.
Another set of rules limiting rental property activity losses are at-risk rules. The IRS states you may be subject to at-risk rules if you have a loss from a trade or business activity or other income-producing activity and you have ”amounts invested in the activity for which you are not fully at risk.” You are considered at-risk for any money, property or borrowed amounts invested in the rental activity. In the majority of cases, losses incurred for at-risk rental activities are allowed only up to the amount that is at risk at the end of the year. Losses that surpass the at-risk limits are carried over to the following tax year and can be used as a deduction from the same rental activities.
Professional Tax Advice
Consult a tax professional for additional tax advice on the best tax treatment for your rental property losses. IRS rules might change from one year to the next, and a tax professional can help you identify the tax rules that apply to you.
Eileen Rojas holds a bachelor's and master's degree in accounting from Florida International University. She has more than 10 years of combined experience in auditing, accounting, financial analysis and business writing.