An investment property can be a moneymaker in boom years, but if the market crashes and you need cash, you may have to sell your investment property at a loss. Although Uncle Sam allows you to use that loss to lessen your tax liability, it’s not as simple as claiming a deduction for the difference between what you paid for the property and the price for which you sold it.
Investment property is considered a capital asset for income tax purposes. Because your loss stems from the sale of a capital asset, the tax implication is calculated separately from your ordinary income. For example, if you have a $10,000 loss on your investment property, you can’t just use that loss to offset your salary income for the year. If you held the investment property for one year or less, it's a short-term capital loss. If you held it for over one year, it's a long-term capital loss.
Figuring Your Adjusted Basis
“Basis” is the tax term used to describe how much money you’ve invested in purchasing and improving the investment property. You can include both the cost to purchase the property and the cost of any improvements you’ve made. However, you can’t include the cost of repairs. For example, the cost of putting in a completely new tile floor would increase your basis because it is an improvement, but replacing chipped tiles on the floor would not increase your basis because it’s a repair. If you’ve depreciated the investment property, you must decrease your basis by the amount of depreciation you’ve claimed over the years.
Calculating Your Losses
The amount of your loss on the investment property equals your sales proceeds minus your adjusted basis. Thankfully, Uncle Sam only credits you with sales proceeds that you actually get to keep after paying the cost of your real estate agent as well as any closing costs. For example, if you sell your investment property for $150,000 but must pay your real estate agent $2,000, your sales proceeds are only $148,000. If your adjusted basis is $158,000, your loss is $10,000.
Limits on Losses
You can use the capital loss from selling your investment property to offset other capital gains during the year. For example, if you sold an investment property at a $10,000 loss but you had $15,000 of capital gains, the loss would offset two-thirds of your gains, leaving you with only $5,000 in capital gains for the year. However, if your capital gains are smaller than your capital losses, you’re limited to a deduction equal to the smaller of $3,000 or the amount by which your capital losses exceed your capital gains. The remaining loss can be carried forward and used in future years. For example, if you have a $10,000 capital loss from your investment property and only $5,000 in capital gains, you are limited to a $3,000 deduction on your taxes. The remaining $2,000 is carried forward.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."