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Like any business-related activity, to calculate your taxable profits from rental activities, you subtract your deductible expenses from your gross income, and if the answer is a positive number, you have a taxable profit or gain. This will be initially reported on Line 22 of Schedule E.
In the case of real estate rental activities, it frequently happens that the answer isn't positive, it's negative, and you have a loss for the year. In some cases it's only a "paper loss" because you deducted depreciation expenses that don't represent out-of-pocket expenses, but in other cases it is a real loss. Investors in real estate are frequently willing to accept small losses in the short term, if they believe that their property will appreciate sufficiently over the years to result in a big gain over the long term.
However, the IRS is ever vigilant against the possibility that you are merely trying to create a tax shelter for other types of income. Therefore, there are some special rules that may prevent you from deducting some (or all) of your real estate losses:
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