Stagnant Sale Status

[Snaggletooth]

Couple has moved to the "Sunny South" from New York.

After a year of trying to sell their house, they have reduced their selling price and have begun to rent it out to help defray the cash drain of paying two mortgages.

There was never an intent to rent the New York house in the beginning, and the house was on the market for nearly a year before deciding to rent the house.

Upon the sale of the house, is there any way to show the rent as additional proceeds instead of filing a schedule E because it was rented for a brief period.

As an additional note, if the rent is shown, the rental home will report a loss. Taxpayer would forego the benefit of reporting a loss in exchange for being able to not report schedule E. The issue is depreciation recapture in the event the house eventually sells.

[JohnH]

I think he's stuck with the "allowed or allowable" issue on depreciation. He will have to recapture depreciation when he sells even if he doesn't deduct it.

[Burke]

Check out the "not for profit activities" rules. If the house is still on the market, and owner is actively trying to sell, just renting temporarily until market improves, then these might apply. Rental income goes on Line 21. (1) Mortgage interest & real estate taxes go on Sche A. (2) Other expenses such as insurance, utiltities, repairs go on Sche A, line 23, up to the gross income remaining after int & taxes are taken. (3) Then depreciation deduction only comes into play if there is still positive income after the first two categories.

[Snaggletooth]

Passive activity

Thanks guys, I think you've hit the nail on the head, but I'm not sure the "not-for-profit" would avoid the "depreciable" definition which requires recapture.

What would happen if:
1) This was rented without active participation. That means they cannot deduct a loss, regardless of their income level.
2) Accumulate these losses until property is sold.
3) Claim the depreciation recapture upon sale of residence.
4) Write off the accumulated losses against the depreciation recapture.

I don't know whether this would work or not, or mechanically how to do this since the sale of a residence would not be reported on a 4797...

[erchess]

My Reflections

1. I think "not for profit" is available in this set of facts. I think that if the rent is set so that expenses which have precedence over depreciation zero out the income then no depreciation is "allowed or allowable".

2. I was taught to basically never consider that a client who owned rental real property lacked active participation unless there was another owner of the property who was making ALL the decisions without consulting this client or the property was owned by a partnership in which the client was a limited partner. I was taught that if the owner of the property selected a manager who was to do or hire others to do all the work on the property then deduct from rental payments the costs of this including management fee and send the profit to the owner that one action was enough for "active participation".

3. Snags I have absolutely no idea whether you can do what your last post suggests or even how you would do it. I mean if we were discussing deduction of vet bills as a medical expense we both know how that would be done yet we both know it's illegal. Your plan is one that neither of us experienced tax pros even knows how it would be done and that makes me wonder if it isn't illegal.

[Snaggletooth]

Thanks

Thanks for your response Erchess. Yes, I wonder if it is legal myself, hence the reason for the post.

I've probably got the "active participation" covered since owner has not been there for over a year and hires a commissioned realtor to collect rent and arrange for expenses to be paid.

[BHoffman]

I'm agreeing with Burke about line 21. No depreciation allowed.

[Snaggletooth]

Bump

I'd like to bump this up again. Some of the more knowledgeable people have indicated we can bail out of the "depreciable" mindset if we use the "not-for-profit" rules, and in general these people usually are more astute than myself.

I have some heartburn with the "not-for-profit" rules because they not only disallow the loss but actually create tax if the client does not itemize. I would rather file a schedule E with equal revenue and expenses, so the activity is tax neutral, and the client is not forced into paying extra tax simply because he has a losing activity he is willing to report as not-for-profit. Of course, who said the rules have to be fair?

For purposes of discussion, assume NO active activity, and:
1) Rent proceeds $8000
2) Depreciation $4000
3) Other expense $6000.

Report a $2000 loss on Schedule E, but have it disallowed on Form 8582.
Then when property is sold in the following year, file Form 4797 showing:
1) Sale proceeds of zero. Property still qualifies as personal residence.
2) Basis of property $2000, consisting entirely of disallowed loss. The cost of
the building is not claimed because it qualifies as a personal residence.
3) Depreciation recapture, $4000.

Entire scenario above results in a $2000 ordinary gain on 1040 coming from 4797.

If you've read through this far, thank you for spending the time. An extra thank you if you care to comment on the situation presented by the numbers above.

[JohnH]

Snags:

I've been following this thread with interest and have learned a thing or two about the "activity not engaged in for profit". For me this has been an enlightening discussion for that reason alone. But I'd like to ask another question.

Back to the initial premise - I don't fully understand the reluctance to report the activity as a normal rental. Since the taxpayer derives a tax benefit from the loss each year, won't the entire transaction be close to a wash when the depreciation is recaptured in the year of sale? There may be a percent or two of net difference one way or the other, and an extra state return to be prepared each year, but that doesn't seem to me to be a big problem in the grand scheme of things.

Furthermore, you posed the question in the context of the house being sold in the next year or so. What happens if the house doesn't sell as planned and the taxpayer winds up renting it for 3,5, 0 years? In the current market, even great plans don't work out as intended.

I'll be interested in the ongoing discussion about the issue, but just wanted to toss that question into the mix.

[Snaggletooth]

Thanks

John, thanks for hanging in there with me.

The particular reason why we wouldn't report a conventional loss is the
income of the client is insufficient to otherwise file. Both are over 65
and their only other income is some $6500 in interest income. Reporting
a loss conventionally does them absolutely no good.

However, if they rent their former residence for 2-3 years and then sell
and have to recapture the depreciation, this may create an income in
excess of filing requirements and taxable to them. Depreciation will be
substantial on any home in the Amityville area of Long Island.

I'm also worried about a gain on their residence of over $500,000, but don't
know about this yet.

Thanks, John H

[JohnH]

OK. Makes sense - I guess I should have figured that out by myself.

I see that they may have another problem as well. If it's been sitting empty for a year already, then if they have to rent it for 2 years they will be outside the "use test" window for the Sec 121 exclusion, or close to it.