Can You Deduct a Loss on Rental Property?


Are you experiencing a loss on your rental property? If so, you’re not alone. With the onset of the pandemic, many renters across the country have been unable to pay rent. This in turn has led landlords to incur rental losses into the billions of dollars.

Without rental income, many property owners must search in earnest for ways to offset the expense. Fortunately, within the current tax code, a certain percentage of rental losses can be deducted.

In this article, we’ll share how a rental property loss tax deduction works, as well as alternative ways property owners can consider to offset their losses.

What causes a loss on rental property?

There are many contributing factors to a loss on a rental property. When the expenses to maintain the real estate exceed the income that it generates, a property owner is experiencing an economic loss and essentially paying out of pocket to keep the property.

These expenses usually include items such as cleaning, yard work and maintenance. They can also include unexpected repairs, mortgage payments, property taxes, and even the cost of vacant units.

However, not all losses in real estate are bad. If you have a property that is generating a positive cash flow, meaning the income is greater than the expenses, you can still have a loss ‘on paper’ due to certain expenses that exist solely when filing taxes, such as depreciation (a tax write off to account for the loss in value of a building over time).

By knowing the type of loss your rental property is incurring, whether real or tax loss, you’ll now have a better understanding of your options to write them off.

How are rental losses treated?

For tax purposes, rental real estate losses are treated as ‘passive losses.’ In the Internal Revenue Code there are two types of income-generating activities: active income, which comes from working full time or running a business; and passive income, which comes from owning rental properties.

As a general rule, passive losses can only offset passive income. This means if a taxpayer doesn’t have any passive income, they won’t be able to use it- even if there is a rental loss.

Specifically, your rental losses will be held in limbo unless you happen to purchase another rental property or generate some other type of passive income in the future. However, there are certain exceptions.

Can you deduct a loss on rental property?

In order to deduct rental property losses, you have to take what is called the ‘rental real estate loss allowance.’ This allowance, however, is only available to those who meet one of the two following scenarios.

The first is if you are a full-time real estate professional, such as an agent or an appraiser. In these cases, you can deduct a rental loss, and there is no limit to the amount you can use to offset both your passive and active income. For example, if you are a real estate agent making $100,000 a year and experience a $40,000 loss on a duplex, you are eligible for a $40,000 tax deduction against your income.

The second scenario in which you can deduct a loss on a rental property is if you actively participate in managing the property, hold at least a 10% ownership interest, and earn less than $150,000 a year. If all of these factors are true, then you are eligible for a rental loss tax deduction of up to $25,000 each year, so long as your income is no greater than $100,000. For taxpayers making more than $100,000, this allowance decreases before phasing out completely if you make more than $150,000 per year.

As an example, let’s say you inherit an apartment building that experiences $30,000 in rental losses each year, and your adjusted gross income is $80,000. So long as you actively begin managing the property yourself, you’ll be able to deduct up to $25,000 of the loss.

However, if you make $300,000 a year, you won’t be able to take any rental real estate loss allowances. Likewise, no matter how much money you make, if you inherit a property and let a full-time property manager take care of it, you won’t be able to deduct any of the rental losses.

How to offset all your rental losses?

Fortunately, individuals who are not eligible to deduct rental property losses have alternative options.

The first is to sell the property for less than it’s worth. In doing so, a taxpayer generates a one-time loss that can be counted against their passive and active income.

This method, however, will only work if the property is sold for less than its original purchase price. For example, if you bought a rental property in 1980 for $100,000 that’s valued at $500,000 today, even if you sell it at loss for $200,000, the IRS still recognizes it as a $100,000 gain and can tax you as much as 30%-50% of the profit.

As this is a common occurrence for many given the current real estate market, the only remaining alternative you have to achieve similar tax benefits is to donate the property to charity. Through a charitable donation, you avoid paying capital gains taxes and can qualify for a tax deduction as large as 20%-60% of your adjusted gross income.

Using the same example from above, let’s say you earn $100,000 a year (which is subject to a 50% charitable donation cap) and instead decide to donate the property to a nonprofit of your choice. If they sell the rental property for $500,000, you’ll be able to write off $50,000 each year against your active and passive income for the next five years!

This is a much better scenario than being limited to $25,000 rental loss deductions each year, and why one of the best ways you can deduct your losses on a rental property is to donate it to a charity.

How donating property to charity helped a Selma family

This is the exact situation a family in Selma, Alabama found themselves in. Four siblings inherited a house when their mother passed away. All of them were living outside of the area, working full-time jobs, taking care of their families, and had four different ideas of what to do with the home.

The idea of renting it came up, but there were too many structural issues with the roof and home for the siblings to tackle on their own. They also quickly learned that because of the passive loss rule they might never be able to completely write off the repairs needed to get the home into sellable condition.

It was then that the family unified and decided to give the property to charity. Through Giving Property’s support, they were able to contribute tens of thousands of dollars to Catholic Charities USA. The family was both relieved and excited that the money was able to go back directly to the community and save them from what would have been a stress on their relationships, their families, and their finances.

If you and your family are in a similar position and want to explore the option of donating your property, contact us at 844-277-HOME or fill out our form: https://givingproperty.org/contact-us.



**This article is for informational purposes only and does not constitute formal advice. Individual tax situations may vary so please contact your tax advisor if needed.