Rental properties can easily supplement your income. Because it is income, you pay taxes on it. But what happens when you suffer a loss? Do you get to “write it off?” As with everything involving taxes, the answer is, “It depends.” Let’s take a look at a few situations. In the Southeast, we’re heading into what we like to call “Hurricane Season,”—that time of year when tropical storms can wreak havoc on homes. Excessive rainfall can flood areas that do not normally flood or high winds can destroy siding or roofs.
Let’s say you have a rental property in Louisiana, near New Orleans. While Louisiana’s recent flooding was not caused by a named storm, excessive rainfall has brought more than 6.9 trillion gallons of rain in one week. Your rental was flooded, and that means you won’t have renters until the home is repaired. So what is your loss?
Let’s start with the casualty loss, a loss resulting from the damage, destruction, or loss of your property from any sudden, unexpected, or unusual event such as a flood, hurricane, tornado, fire, earthquake, or volcanic eruption. First, is your property partially or totally destroyed? If the home was totally destroyed you can deduct your adjusted cost basis, minus any insurance proceeds. For example, you purchased the home for $103,000 and over the years, you’ve deducted $13,000 in depreciation. Your adjusted cost basis is $90,000. If insurance covers $50,000, your loss is limited to $40,000.
Now, if your property suffered only a partial loss, you can deduct the lesser of your adjusted cost basis minus insurance proceeds or the difference between the property’s value before the disaster and the value after the disaster, minus insurance reimbursements. For example, let’s say the home was worth $145,000 and now after the flood, the value has dropped to $100,000. The difference is $45,000. If insurance covered $25,000, your loss is limited to $20,000.
While the example is pretty simplistic, the basic gist is that it is possible to deduct a loss if insurance doesn’t cover the complete loss. Unfortunately, unless you have business insurance to cover the lost rent during the repair, you’re out that income.
Now, if the disaster is widespread causing severe damage, the government may deem it a federally declared disaster zone. Casualty loss rules still apply, but this declaration allows federal programs to come in and help with rebuilding. It also allows affected taxpayers to amend the prior year’s return to claim the loss and get their refund sooner, which can help with cash flow to get the repairs done sooner.
OK, not everyone has a flooded rental property. Sometimes you just have a loss as part of doing business. Say you’ve earned $10,000 in rental income during the year and you paid $8,000 in expenses and claimed $4,000 in depreciation, resulting in a loss of $2,000. Generally, with passive income, you can only claim a loss when your passive income exceeds your passive loss. However, those who materially participate in rental activities can deduct up to $25,000 a year against income from other sources. The loss is limited to those whose modified adjusted gross income is less than $100,000. The maximum loss limit is phased out for those with MAGIs between $100,000 and $150,000.
The good news is that if your income exceeds the limitations, losses can carry forward to years when your income is lower or you eventually sell the property.
Rental properties can complicate your taxes, and that is even more evident when you suffer a loss on your property. This is just a simple overview of how you may deduct a loss. Many other factors could affect your specific situation. If you’ve suffered a loss, you should consult a C.P.A. or other tax professional to help with your tax situation. If you have questions, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.