Understanding Passive Losses
Passive losses occur when deductions or credits from a passive activity exceed the income generated by that activity. Passive activities include trades or businesses where the taxpayer does not materially participate. For rental real estate owners, especially those not classified as real estate professionals, passive losses can only offset income from other passive activities. This means a full-time professional, like a doctor owning a retail strip center, can only use losses from the property to offset passive income, such as rents received from that center, not their active income from practicing medicine.
How Cost Segregation Studies Affect Passive Losses
A Cost Segregation Study can accelerate depreciation deductions on rental properties, creating significant tax savings. However, for passive investors, these increased deductions can only offset passive income. If the depreciation deductions exceed the passive income from the property, the excess is classified as a passive loss. This excess passive loss can then offset passive income from other rental properties or be carried forward to future years.
Carrying Forward Passive Losses
Passive losses that exceed passive income are not wasted. They can be carried forward indefinitely to offset future passive income until fully utilized. For instance, if a Cost Segregation Study generates $100,000 in depreciation deductions but you only have $50,000 in passive income, the remaining $50,000 can be carried forward to offset future passive income.
Disposition of Passive Activities
If a rental property is sold to an unrelated party in a transaction where a gain or loss is recognized, any suspended passive losses become fully deductible. For example, if a doctor sells their interest in a retail strip center with $50,000 in suspended passive losses, these losses can be used to offset the doctor’s active income, providing significant tax relief.
Exception to Passive Loss Rules
There is an exception allowing taxpayers to deduct up to $25,000 of passive losses from non-passive income, such as wages or dividends. To qualify, the taxpayer must actively participate in the rental property’s operations. Active participation involves regular, continuous, and substantial involvement in managing the property. This deduction begins to phase out when Adjusted Gross Income (AGI) exceeds $100,000 and is completely phased out at $150,000.
Contact Alpine West Group for a Cost Segregation Study
Ready to unlock the potential tax benefits of your rental property? Contact Alpine West Group today. Founded by Andrew and Alicia Hess, we specialize in nationwide self-storage acquisitions and offer expert Cost Segregation Studies to help you maximize your investment returns. Our personalized, family-owned approach ensures that you receive tailored strategies and professional guidance.
Disclaimer
This article is presented by Alpine West Group in collaboration with CSSI® – Cost Segregation Services, LLC. The information contained herein has been sourced from CSSI® with their permission. Alpine West Group utilizes the CSSI® process for conducting cost segregation studies. These studies are a crucial tax savings tool for maximizing the financial benefits of commercial real estate investments.
