Can I Defer an Investment Loss to Next Tax Year?

Dear Tax Talk, I have five rentals that generated a passive activity loss, or PAL, of $25,000 for 2011. Since I materially participated, I know I may use the PAL to offset $25,000 of other income. I have $30,000 of other income, but I don't want to use the entire $25,000 PAL to offset my income because it would reduce my adjusted gross income, or AGI, to $5,000. After the standard deduction and exemptions, my taxable income would be negative. Can I elect to use less than the $25,000 PAL (say, $10,000 of my PAL to offset my income and defer the remaining $15,000 for next year)? -- Ralph

Dear Ralph, Unfortunately, too much of a good thing is proving to be a bad thing. Losses from rental activities are usually limited to the income from those and other passive activities. A special allowance of up to $25,000 in losses is allowed to taxpayers whose AGI is less than $100,000. Any losses not allowed because of the loss limitations or AGI limits are suspended and carried forward to future tax years to be used against similar gains. However, any loss not utilized because of insufficient other income isn't part of your passive activity loss carryover.

In certain instances, these excess passive losses may generate a net operating loss, or NOL, which can be used to carry forward apart from the passive loss carryforwards. An NOL exists when you have 1) negative AGI as a result of business losses or 2) negative taxable income as a result of business losses and sufficient nonbusiness income such as interest and dividends to offset nonbusiness deductions such as adjustments to AGI or itemized deductions. An individual NOL is a complex calculation and in most cases would not be as beneficial as just carrying forward the passive losses.

There is no election to reduce the $25,000 allowable loss. In other words, if you're entitled to the $25,000 deduction, you have to claim it regardless of your other income. However, if you're married, filing separate from your spouse may reduce the $25,000 allowance. Passive losses allowed for married taxpayers filing separately are either $12,500 (if they did not live together) or zero (if they did live together during the year).

While too late for 2011, if you're in the same situation in 2012, you can try to minimize your losses so that you don't have the full $25,000 loss. You can minimize losses in 2012 by either accelerating rental income or deferring repairs or other expenses such as property taxes. It may make sense to forgo bonus depreciation on current-year additions of depreciable property such as appliances or furnishings. (This can also apply to additions during 2011). You can also look at increasing your other income by taking individual retirement account distributions or making an IRA conversion to a Roth.

If you're concerned you're losing deductions, hire a CPA before filing your return.

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