Rental property tax deduction question?

Question

We upgraded from a townhouse to an SFH last year and rented out the TH. Taxwise, my rental income does not cover the property tax+mortgage interest+depreciation+maintenance so I'm not getting any deduction off this loss.

My question is, let's say I kept this property for 5 years and sell it then, how will the cost basis be calculated at that time? Will IRS take the depreciated amount off my cost basis even though I get no benefit out of it?

Thanks

Answer 1

When reporting the sale of or computing gain or loss on rental property, you are required to make an adjustment to your basis for allowable depreciation regardless of whether the deduction was taken.

Passive Activity losses : In general, you can deduct passive activity losses only from passive activity income (a limit on loss deductions). You carry any excess loss forward to the following year or years until used, or until deducted in the year you dispose of your entire interest in the activity in a fully taxable transaction.

Refer to Publication 527, Residential Rental Property and Publication 925, Passive Activity and At-Risk Rules .

Answer 2

Why are you not taking the loss on the rental property? You're entitled to it! It may be limited by the Passive Activity Loss rules (generally $25,000) but if the expenses are more than your rental income you most certainly can and should use to loss to offset other income!

When you sell, you must reduce your cost basis by the depreciation allowed OR ALLOWABLE while the property was being rented out. Watch out for that "OR ALLOWABLE" stipulation. Even if you didn't take the depreciation expense deduction, you MUST adjust the cost basis by the amount of the depreciation that you COULD HAVE TAKEN.

Answer 3

If your Schedule E shows a loss, that is transferred to the 1040 and reduces your taxable income. So you are getting a tax benefit from the rental property.

Whether you are getting any tax reduction or not, the depreciation allowed or allowable reduces your basis in the property. Therefore, your gain is greater. Gain due to depreciation is taxed as ordinary income. Gain above that amount would be taxed as capital gains, which would be long-term capital gains as long as you owned the house for more than one year.