Inflation affects everything, from the cost of living to investment returns. Yet, some critical tax deductions and allowances remain stuck in the past, untouched by inflation adjustments. One glaring example is the $25,000 special loss allowance for real estate investors. Despite being established decades ago, this allowance has never been adjusted for inflation. In this post, we'll delve into what the $25K special loss allowance is, how it's currently affecting real estate investors, and why adjusting it for inflation could bring much-needed relief.
The $25,000 special loss allowance, introduced in 1986, was part of the IRS's broader initiative to limit passive loss deductions. This allowance allowed taxpayers with an adjusted gross income (AGI) below $100,000 to offset up to $25,000 of passive real estate losses against non-passive income like W-2 wages. This provision was particularly beneficial for those who didn’t qualify as real estate professionals but still incurred passive losses from their investments.
However, the figure of $25,000 has remained unchanged since 1986. If it were adjusted for inflation using the Consumer Price Index (CPI), that amount would be around $69,675 today. This static threshold significantly diminishes the allowance’s effectiveness in the current economic climate.
Adjusted Gross Income (AGI) or Modified Adjusted Gross Income (MAGI) Thresholds:
Phase-Out Calculation Example for Married Filing Jointly:
No Allowance Above $150,000 MAGI for Married Filing Jointly:
Investor A owns several rental properties and generates passive losses of $70,000 annually. Under the current law, only $25,000 of these losses can be used to offset non-passive income. This limitation results in higher taxable income and a greater tax burden.
Now, if the $25K special loss allowance were adjusted for inflation to approximately $70,000, Investor A could offset nearly all passive losses against their income, leading to substantial tax savings. This adjustment could free up more capital for reinvestment or personal use, providing a significant financial cushion.
The $25,000 special loss allowance isn't the only provision suffering from inflation neglect. Other tax rules, such as the Section 121 home sale exclusion, business gift deductions, and startup cost deductions, have also remained static for years.
It's essential to consider that adjusting thresholds for inflation could have mixed effects. For example, the criteria to qualify as an accredited investor have remained unchanged for decades. If these were adjusted for inflation, the income threshold for a single filer would jump to $634,000, and for a married couple, it would rise to $951,000. The net worth requirement would increase from $1 million to over $3 million, drastically reducing the number of individuals eligible for certain investment opportunities.
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