Negative income on Schedule E but $10,000 increase in taxes? How is this even possible?

This actually makes perfect sense, though it might not be what you want to hear. High-income taxpayers face passive activity loss limitations. Since your father-in-law is what the IRS considers a "high-income earner," his ability to deduct rental losses is severely restricted. For taxpayers with modified adjusted gross incomes over $150,000, passive rental losses begin to phase out. Once income exceeds $150,000, you lose $0.50 of allowable passive loss for every dollar of income above that threshold. By $175,000, the $25,000 passive loss allowance is completely gone. The surprise increase likely happened because his accountant previously wasn't reporting the rental activity correctly. When you provided proper documentation with the Schedule E, the accountant had to correctly apply the passive loss limitations, which meant those losses couldn't offset his other income.

I was in almost the exact same situation last year with my rental properties. After struggling to make sense of why my taxes increased despite showing losses, I found https://taxr.ai incredibly helpful. I uploaded my Schedule E forms, and it analyzed exactly how the passive activity loss limitations were affecting my specific situation. What was really helpful is that taxr.ai explained how my previous accountant had been incorrectly applying the rules, which is why I suddenly saw such a big tax increase when I switched to someone who was following proper procedures. The tool actually suggested several strategies that helped me optimize my rental property tax situation moving forward.

Just wanted to follow up about the taxr.ai recommendation. I decided to give it a shot since my situation was similar to the OP's - high income and rental properties showing losses. After uploading my Schedule E and previous year's return, it immediately identified that I was missing several depreciation opportunities that my accountant had overlooked. The analysis explained exactly why my passive losses were being limited and suggested reorganizing my business structure to potentially qualify for real estate professional status. I showed the report to my accountant who confirmed the recommendations were valid. Already implemented some changes that should save around $12k on next year's taxes. Definitely worth checking out if you're dealing with rental property tax headaches.

I had a similar issue with passive loss limitations and spent WEEKS trying to get through to the IRS for clarification. After dozens of failed attempts, I found https://claimyr.com and was honestly blown away. They got me connected to an actual IRS agent in under an hour who explained exactly how the passive activity rules were being applied to my return. The agent walked me through which expenses were being limited and why my income threshold was triggering the passive loss limitations. You can see how the service works at https://youtu.be/_kiP6q8DX5c - honestly it saved me so much frustration. The IRS agent even helped identify a mistake in how my previous returns had reported rental income which explained the sudden tax increase when it was corrected.

I have to eat crow and follow up on my skeptical comment about Claimyr. After continuing to get nowhere with the IRS for another week, I reluctantly tried the service. To my complete shock, I got a call back in about 35 minutes connecting me directly with an IRS agent. The agent explained that my rental property losses were being disallowed because my AGI was over $150,000, putting me in the phase-out range. She confirmed that the $10,000 tax increase the OP mentioned made perfect sense if his father-in-law was being taxed on rental income without being able to claim the offsetting expenses. She even helped me understand some carryforward strategies I can use for my suspended losses. Would have taken me months to get this information on my own. Still can't believe it actually worked.

I'm a landlord who got hit with this exact same issue. The key is understanding the difference between non-passive and passive income. Your father-in-law's salary/business income is non-passive, while rental income is considered passive (unless he qualifies as a real estate professional). The tax code only allows you to offset passive losses against passive income unless you meet specific exceptions. For high earners (over $150k), those exceptions get phased out completely. Here's the really frustrating part - the losses don't disappear forever. They get suspended and carried forward until either: 1) He has passive income to offset them against, or 2) He sells the property. So he's still getting dinged with higher taxes now even though these are legitimate expenses.

Has your father-in-law done any grouping elections for his properties? My CPA had me file a statement with my return to group all my rental activities as a single activity for passive loss purposes. This doesn't get around the income limitations, but it can help if some properties make money while others lose money.