Rental depreciation expenses can be used to offset passive income, which includes rental income, as allowed by the IRS.
This means that property owners can deduct a portion of their depreciation expenses from their rental income to reduce their taxable income.
The Tax Cuts and Jobs Act (2017) introduced the concept of "excess business loss," which limits the amount of business losses, including rental losses, that can be used to offset ordinary income.
The annual depreciation limit is 3,000, which means that property owners can deduct up to this amount of depreciation expenses from their ordinary income each year.
After reaching the annual depreciation limit, any excess depreciation can be carried forward to future years and used to offset future ordinary income.
Property owners can use rental depreciation to offset passive income from other sources, such as investment properties or partnerships.
The passive loss limitation (PAL) rule is an exception to the tax law that restricts the amount of passive losses, including rental losses, that can be used to offset ordinary income.
The IRS defines "active participation" as being involved in the management and operation of the rental property, which is required to qualify for the passive loss allowance.
The annual passive loss allowance is $25,000 for individuals with modified adjusted gross incomes (MAGI) of $100,000 or less.
Property owners with MAGI above $100,000 can potentially use the passive loss allowance if they can demonstrate "active participation" in the rental activity.
Rental property owners with AGI above $150,000 (married taxpayers filing separately) or $250,000 (all other taxpayers) may need to use the "passive loss" rules to limit the amount of passive losses that can be used to offset ordinary income.
The recovery period for depreciation of a residential rental property is 27.5 years, which means that the property can be depreciated over a 27.5-year period.
Property owners can choose the General Depreciation System (GDS) or the Alternative Depreciation System (ADS) to calculate depreciation expenses.
Rental property owners can use Form 4562, Depreciation and Amortization, to report depreciation expenses on their tax return.
Taxpayers must maintain accurate records of rental income and expenses, including depreciation, to support their tax return claims.