Thanks for the reply. i was under the assumption that the rental property could be treated as a business, and that losses on the property are only tax deductible when the household income is under $150k. Is this not correct?
Your parents, no matter their income, can always deduct rental expenses from rental income. For many small rental "businesses," this is all that comes into play -- say you have $20K in income, and then $15K in various expenses (depreciation, utilities, interest, supplies, repairs, legal, taxes, insurance), that leaves you with only $5K of taxable rental income. As Waltworks points out, spending $40K on capital improvements doesn't mean you suddenly go from $15K expenses to $55K expenses -- at that level, you're talking about capital improvements that require a depreciation schedule, in which case the portion of the expense that you "count" each year will be small, because you'll spread it out over a period of time.
That said, it's totally possible to run an on-paper loss with a small rental business (I do!). If your parents have a MAGI (Modified Adjusted Gross Income) of under $150K, and if they qualify as "active participants" in their real estate business (Google "special allowance for rental real estate activities with active participation"), they can subtract that business loss from their other (non-rental) taxable income. Example: Rental income of $20K; rental expenses of $25K. Taxable rental income is $0, and then they can also subtract the $5K loss from their taxable income.
Note that $150K is MAGI, not gross income -- it's possible that you (and they) think of their income as being over $150K, but their MAGI could be under the limit.
If MAGI is indeed above $150K, you are correct that they cannot subtract rental losses from other income. However, they can bank those losses and count them in a future year when their rental is an on-paper profit (to reduce or eliminate any taxable rental profit at that time), or when their overall MAGI is lower (in which case losses could be deducted from other taxable income). These are called "unallowed losses" and they're recorded on Form 8582 as part of a tax return. So even if they're not worth anything now, they can have value in a future year.
I have no wisdom for you on how to properly split this rental business with your parents, however!