Tax question - Posted by Edwin

Posted by Dave T on April 09, 2010 at 22:45:48:

I stand corrected.

Tax question - Posted by Edwin

Posted by Edwin on April 08, 2010 at 11:44:19:

I paid $114,000 in mortgage interest last year, but only needed about $35,000 of that to zero out my tax liability. Can I apply the rest of the interest to my basis to offset any profit when I sell, or is that “undeducted” interest gone forever?

Thanks!!

Re: Tax question - Posted by randyOH

Posted by randyOH on April 09, 2010 at 11:21:30:

You may have a “net operating loss” that can be carried back to a prior year and receive a refund of the taxes you paid in the prior year.

Re: Tax question - Posted by Dave T

Posted by Dave T on April 08, 2010 at 21:47:06:

Just curious. Is this mortgage interest on your investment rental property? If so, then are you a real estate professional?

Re: Tax question - Posted by EDWIN

Posted by EDWIN on April 09, 2010 at 16:21:44:

Thanks, Randy, I think that’s correct. After I posted the question I researched more and it also appears that mortgage interest that is not deducted can be carried forward and added to the basis to offset any gain when you sale. I’m not sure if you can apply it against future income, but it seems likely you could.

Re: Tax question - Posted by Edwin

Posted by Edwin on April 08, 2010 at 22:42:01:

Yes, Dave, it’s interest in investment rental property. I qualify as a real estate “professional,” as least as far as the IRS, by virtue of the time I spend on RE activities

Re: Tax question - Posted by randyOH

Posted by randyOH on April 09, 2010 at 17:52:12:

Edwin,
I am not aware of any tax rule that allows undededucted interest expense to be carried forward and added to basis. Could you provide a reference to this rule?

Thanks

Re: Tax question - Posted by Dave T

Posted by Dave T on April 09, 2010 at 19:24:12:

Since the property is your rental real estate which you report on Schedule E, you get the passive loss allowance only if you claim “active” participation.

Couldn’t you deny active participation for some or all of your rental properties to reduce your passive loss allowance and therefore suspend your losses. This way you document your mortgage interest expense on your tax return, and, the suspended losses will offset your capital gains when the property is sold,

I don’t think a rental activity can generate a “net operating loss”, since a rental activity is not an active income business. Instead, unused passive losses are suspended and carried forward to future years.

Just how I see it. Consult your CPA for specific guidance.

Re: Tax question - Posted by Edwin

Posted by Edwin on April 09, 2010 at 19:46:41:

Randy, I spent a few minutes looking, but was not able to find that website that I saw last night that seemed to indicated interest can be carried forward. Sorry. But I did find some other references that seem to say essentially the same. I’m very nervous about saying anything, because I am NOT a tax expert and could have this completely wrong, but it appears that mortgage interest, and other operating expenses that exceed income can be carried forward as a NOL. I believe there is a limit of $3,000 per year whereby this carried forward loss can be applied against future income, except there is no $3,000 limit when applied against capital gains on a sale.

That said, it’s important to realize that the tax rules for owner-occupied properties are not always the same as for vacation or second homes and investment properties that are full-time rentals. Much of the tax advice out there seems geared towards owner-occupied and second home properties, and if you don’t pay attention, it’s easy to get the wrong information. Generally, it appears that expenses for investment property are given more latitude in how and when they can be deducted. For example, mortgage interest on personal homes occupied by the owner are only deductible in the year paid. But the same interest paid on an rental house can be deducted in the year paid, and any excess can be carried forward and deducted or applied against any gain.

I also discovered something called the “Uniform Capitalization rules.” I quote from IRS publication 535: “Treat capitalized interest as a cost of the property produced. You recover your interest when you sell or use the property…If the property is used in your trade or business, recover capitalized interest through an adjustment to basis, depreciation, amortization, or other method.”

The following links might be helpful:

http://www.delphifaq.com/faq/f1324.shtml

http://www.irs.gov/publications/p535/

Again, I could be completely wrong about all this, so I apologize if my conclusions are wrong, but for now I feel pretty safe with my understanding.

Re: Tax question - Posted by randyOH

Posted by randyOH on April 09, 2010 at 18:04:16:

Correction: “undeducted” interest.

Sorry for the typo.

another factor is… - Posted by David Krulac

Posted by David Krulac on April 10, 2010 at 22:53:39:

if you are in a higher tax bracket like the 35%, it would be more dollar effective to take the losses currently against you oridinary income, either at the $25,000 passive loss, or higher if you are a real estate professional.

The alternative would be to deduct these losses against capital gains when the property is sold, but at least for 2010 the capital gains rate for most people is only 15%.

therefore the losses carry more wieght if dedcuted against the ordinary taxes at 35% than capital gains at 15%

Re: Tax question - Posted by randyOH

Posted by randyOH on April 09, 2010 at 19:51:17:

>>>I don’t think a rental activity can generate a “net operating loss”…<<<

I beg to differ:

http://www.irs.ustreas.gov/publications/p536/ar02.html

Re: Tax question - Posted by randyOH

Posted by randyOH on April 09, 2010 at 20:03:15:

Edwin,
You are really confusing a lot of different tax rules. I will not attempt to address all of the errors in your thinking, but here are the only two ways I know of that you could carry interest expense forward to a future year.

  1. Elect to not carry back your NOL. You would then be able to use it as a deduction in future years.

  2. Do not elect RE professional status. Then your “suspended losses” would be carried forward to future years (as DaveT suggested).

If you have questions about any of the other tax rules you mentioned in your post, I would be happy to address them separately.

Re: another factor is… - Posted by randyOH

Posted by randyOH on April 11, 2010 at 11:17:39:

Suspended losses are not added to the basis of a property. They do not, therefore, reduce capital gains when the property is sold.

When a property with suspended losses is sold, the losses are deducted on Sched E and therefore offset ordinary income.

This is a very common misconception about how passive losses are handled.