Deductible Losses on a Rental Home

Many people are facing losses on real estate sales, made to get out from under a weighty mortgage. This begs the questions, if you pay tax on real estate gains, do you get a break from real estate losses? The answer is logical, but only after you understand how gains on real estate are taxed.

Capital Gains Tax

The IRS does not always charge you taxes on capital gains. If you profit by $250,000 as a single seller, or $500,000 as a couple, you do not have to pay capital gains tax. You only pay for profits above those amounts.

Therefore, the logic follows that you would not get a break if you lost money on the sale of your home. However, exceptions do exist for those who sell an investment property. What qualifies as such a property? Any real estate that brings income qualifies, such as a rental house or vacation home that you rent out part of the vacation season.

How Much Can You Deduct?

The IRS lets you deduct losses up to specific amounts. Depreciation is also deductible, which can really muddy the waters when figuring your taxes. For this reason, it’s best to talk to a tax professional to figure out exactly how much you can deduct. Claiming losses on investment property requires a completed IRS form 4797.

When selling a second home, you generally pay taxes as long-term capital gains for properties owned over one year or short-term capital gains one homes owned less than one year. If you would pay capital gains on a profit from the sale in these situations, then you would be able to deduct a loss.

Don’t Think of it as a Second Home

When you think of the rental property as a “second home,” you muddy the waters. The IRS allows certain deductions on a second home, but they do not allow deductions on losses for these properties. The difference is the purpose of the property. Is it truly a “second home” or is it an investment? Are you earning income from it?

Dealing with Depreciation

Most people who rent out a property take depreciation every year. When you sell the property, that depreciation counts against the value of the property, reducing your tax-deductible loss. The good news is that the loss is deduct-able as an ordinary loss, deduct-able in full against the income. Limits apply and you must also address the issue of passive losses. This complicated topic definitely requires the help of a tax professional.