Here’s the deal on rental losses. If you’re not a real estate professional, real estate rental income is always passive. If the owner actively participates in management, net losses from all rental property of up to $25,000 per year can be used to offset other income, unless modified AGI is over $100K. If modified AGI is over $100K, then the loss limitation is reduced by $1 for every $2 of income, with the deductible losses completely phased out at income of $150K. (those numbers are cut in 1/2 for married taxpayers filing separately.) Unallowable losses are carried over until they can be fully used, or until the properties are disposed of, at which time all previously un-allowed losses can be deducted.
None of this means that the “tax shelter” aspect of real estate is lost, even for higher income taxpayers. If there is positive cash flow, but non-deductible losses for tax purposes, that cash flow is still tax-free (for the time being). Given all the talk I’ve read here over the last few months, about 7% plus cash on cash returns, this really shouldn’t cause much of a problem for recent investors. Even with 20% down payments, if cash flow is really 7% plus, tax losses should be pretty small. With 30% or more down and that kind of return, there won’t be any losses at all in most cases. But there will still be tax sheltered income.
