When you sell an individual property what you do with excess deductions is set by if there's tax on the sale.
Excess deductions and a non-taxed property sale
Most of the time there's no tax to pay when you sell a residential rental property and make a gain. When this happens you need to know what to do with any excess deductions.
When you've sold your individual property and the sale is not taxed its excess deductions are either:
- transferred to another residential rental property (if you have one)
- carried forward from year to year if there's no residential property to transfer them to.
When you get more residential property you transfer your unused excess deductions to it. (These are the ones you've carried forward.) You then:
- treat them as transferred to that individual property or portfolio
- deduct them when you earn income from the residential rental property.
Excess deductions and a taxed property sale
Sometimes there is tax on the sale of residential rental property. This could be when you sell within the bright-line period.
Selling property and the bright-line rule
If you sell an individual residential rental property and the sale was taxable you can use your excess deductions. You can use them against:
- net income from the property sale
- your other income, such as salary and wages.
You cannot use transferred excess deductions for your taxable sale. These are excess deduction from another residential property. If you have transferred excess deductions remove them from your property's excess deduction total. You'll need to do this before using excess deductions against your other income.
If your excess deductions are more than your other income they become part of your net loss. You can carry them forward and use them against other income in future years (like any other net loss).
Nikita has three residential rental properties. Properties A, B, and C.
Properties A and B are in a portfolio. Nikita uses the individual property basis for property C.
Nikita's has salary income of $70,000.
Property C has excess deductions of $80,000.
Nikita decides to sell property C. It's a taxed sale. His net income from the sale is $60,000.
Because the sale was taxed Nikita can use $60,000 of excess deductions against the net income from the sale.
Nikita still has $20,000 of excess deductions left over from property C. He can release these and use them against his salary income. He can do this because he used the individual property basis for property C.
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