Monday February 3, 2014
Dear Clients and Friends,
Selling your rental property? If the answer is "yes," I have good news for you. You can now deduct all those passive losses you couldn't deduct in previous years.
Normally, your rental properties suffer losses but the law assumes that you do not really suffer real economic loss in the process. With the "passive loss" deduction test, most rental property owners are not able to take advantage of the tax loss deduction but instead they have a suspended losses account waiting to be released until they pass the test or sell their property.
Here are four ways of turning your passive losses into tax deductions successfully when you sell your rental properties:
#1: Know how to deal with the "entire interest rule" so you take the maximum tax benefit when you sell your rental properties.
As a rule, you sell your entire interest including your suspended losses in the activity. By default, each of your rental property is a separate activity. However, the IRS gives you an option to group all your rental properties as one as well.
For tax deduction purposes, it benefits you to keep your rental properties as individual or separate activity so that you get to free a part of your suspended losses every time you sell a part of your rental properties.
However, if you chose to group your rental properties, you sell your entire interest and free your suspended losses only when you sell all the rental properties.
#2: Know to whom to sell your rental properties and make sure they are not sold to your relatives directly.
The passive loss test does not allow you to free your suspended losses when you sell to relatives. This means selling to any of the following:
e) Corporations that you own 50%
f) Corporations that you and your brother own 50%
In short, you can sell to in-laws and everyone else. However, should you have no choice but to sell to the above stated relatives, your suspended losses remain until your relative sells the property to other people unrelated to you. And yes, the suspended losses remain and simply wait till the property goes to the unrelated buyer.
#3: Know what to give away and that does not include your rental properties.
When you give away rental properties, it's like selling them as well for nothing in exchange. This means you also set your suspended losses free. Your suspended losses go with the properties.
Therefore, a rental property of $200,000 that has a $20,000 suspended losses is valued at $220,000 when you give it away. If you give it to your child and he sells it for $250,000 he only gets a $25,000 capital gain. In other words, you are left with no suspended losses to match your other income and your son gets less tax benefit basis too.
#4: Know that your suspended losses remain as long as you live so stay alive as much as you can to enjoy this tax deduction.
When you die your properties are revalued and this is the new basis for your heir's property. The suspended losses released upon your death are limited to the amount that exceeds the basis step-up value of your property.
For example, you left a $200,000 rental property and a $20,000 suspended losses to your heirs. This was revalued at $1,000,000 on your death. The property appreciated in value with an $800,000 increase which is also the basis step-up value.
Since the suspended loss of $20,000 do not exceed the step-up in basis of $800,000 then the loss is forever lost. It dies with you with no tax benefit to anyone. However, your heirs do avoid the tax on the property appreciation.