Real estate investors may collect untaxed cash flow because depreciation deductions can turn taxable income into tax losses. If so, can they deduct the loss from their ordinary income that year? Perhaps, under the "passive activity loss" rules.
For most taxpayers, passive losses up to $25,000 per year can be deducted. To take the maximum $25,000 loss, your adjusted gross income (AGI) must be under $100,000. If your AGI is over $100,000, your maximum deductible loss is reduced until it disappears at $150,000 in AGI.
Suppose, for example, Joan Wilson’s AGI this year is $130,000. She is 60 percent through the $100,000-$150,000 phaseout range so she can take only 40 percent ($10,000) of the $25,000 maximum deduction.
If Joan has an $8,000 loss from rental property this year, she can deduct all of it. However, if her loss is $14,000, only $10,000 can be deducted this year. The other $4,000 can be deducted in the future, when the property produces taxable income or when it is sold.
