Tax Guru-Ker$tetter Letter
Thursday, August 27, 2009
Deducting Rental Losses
Subject: Rental property
Dear Kerry Kerstetter,
One of your clients is our friend and realtor. We are thinking about investing in rental property for tax purposes and later to use as a retirement source once the properties are paid for.
She told me that you have helped her so much regarding taxes. She suggested I should contact you to ask the following question.
If you are in the 35% tax bracket- do you get a better tax break by having the rental property under our names or by setting up a corporation to manage the rentals. We just want to be sure there will be a tax benefit by obtaining rental property and we have been given different advise and are not sure which is correct. She said you would know the answer to this question.
Thank you for your time.
You are going to need to work with your own personal professional tax advisor on this matter because there is no easy cut and dried answer.
For example, it depends on what occupations you and your husband have. If either one of you qualifies as a Real Estate Professional (REP), you will be able to deduct your net rental losses against your other kinds of income, with no limit.
However, if neither of you qualifies as an REP, your net rental losses will be treated as nondeductible passive activity losses and will have to be deferred until future years when you have some passive activity profits, such as from the sales of rental properties.
I can tell this by the fact that you claim to be in the 35% Federal tax bracket, which means your Taxable Income is well over $300,000. The passive activity restriction phases out any rental loss deduction if your Adjusted Gross Income exceeds $150,000.
Using a C Corp sometimes makes sense because it is allowed to deduct rental losses up to the amount of other income. However, there is a downside to owning real estate in C corps because they don't have the same special low long term capital gains tax rates that individuals can use.
A strategy that may be able to give you the best of both worlds is to own the property individually and lease it to your C corp, which can then operate it as a rental.
Your C corp would need to have net income from other operations in order to be able to claim the rental losses. If you don't already have a C corp, even without the rental property issue, one could be used to shift some of your 1040 income so that you aren't in such a high tax bracket. I have a lot of info on using corps on my website.
Your own personal professional tax advisor should be able to help you come up with the best strategy for your particular situation.
Thank you so much for your response. If you should ever take new clients please keep us in mind. This information was very helpful and I will look at your website.