Selling rental property at a loss can help you big time at tax time

There are many benefits to owning and holding rental property. We all know them well: passive income, appreciation in value, depreciation opportunities in regards to your taxes, etc.

But what about when you sell your rental property? Sometimes when you choose to divest, you stand to take a loss on the price. However, selling your rental property at a loss doesn’t necessarily mean you’ve lost.

Before you try to determine what your loss would be on your rental property if you sold it, you have to figure out your cost basis. Your cost basis (often just called “basis”) is the price you paid for a property, plus associated closing costs and any improvements (not maintenance costs) you made.

Let’s say we purchased an investment property for $100,000, with $5,000 in closing costs, plus $15,000 in upgrades. This puts us all-in with a cost basis of $120,000.

Now, let’s say in a pinch that you need to sell your property for $95,000. To figure out your loss, you subtract your cost basis plus associated costs ($120,000 altogether) from your selling price, $95,000, a loss of $25,000. At first glance, it looks bad, until you realize you’ve claimed $30,000 in depreciation during the time you’ve owned the property. And because the IRS requires you to recapture your depreciation, you come out with a gain of $5,000—not terrible!

Gains from the sale of rental property are taxed as capital gains, but a loss on sale of rental property is considered an “ordinary loss.” Typically, the IRS allows you to carry forward a loss if you don’t have gains to offset that loss at year’s end, and you can claim up to $3,000 worth of losses against your other income on your tax return.

Unfortunately for us creative business minds, we can’t sell our primary residence at a loss and reap the tax deduction benefits. The reason why? The IRS doesn’t count tax gains made from selling your personal residence for a profit. (That would be sweet, though, wouldn’t it?)

As any savvy investor knows, it’s important to enter into any investment with an exit strategy. We all love to reap the benefits of cash-flowing properties and tax shelters. When it’s good, it’s usually great. However, it is important to recognize when a property is under-performing or has “outlived its worth.”

Sometimes, you choose to divest and get out of one asset class into another. Or sometimes you get in a bind and it becomes necessary to take a loss on the sale price, but when structured correctly, as outlined above, you can create a win out of a loss. This is a key reason why it’s of paramount importance to have the right team members to ensure your success as an investor.

Hire a great CPA and consult with him or her regularly to maximize every possible avenue for tax breaks. You can’t go to war without an army, after all!

Author’s note: I have lots of experience with real estate investing, sales, and property management, but I am not a licensed certified public accountant. So before you think about selling your property, please consult a CPA who is knowledgeable about rental and investment properties.