Sale of deceased residence by estate

[origun]

Home of deceased was sold by estate 2 years after death to unrelated party. Proceeds were distributed to 3 heirs. An appraisal was done shortly after death and home was listed for sale at that price. Because of declining housing market, when the house eventually sold, selling price was almost $100,000 less than appraisal at date of death. I believe there is an investment loss that can be passed on to heirs' K-1s from final 1041. (No one lived in the house in the interim and it was not rented.)

However, there is one thing that bothers me: I have read about IRS Memorandum SCA 1998-012 from Office of Chief Counsel which seems to say the loss can't be taken "unless it has been converted to an income-producing purpose."

Can taking a loss be justified since the residence has been converted to an investment by the estate?

[Koss]

Sale of Residence

I've read through most of SCA 1998-012. The analysis and discussion are extremely fact-bound, and the opinions and interpretations appear to hinge very heavily on New York and New Jersey real property laws.

One of the more generic statements found in this document reads as follows:

We believe that the conversion of the decedent's personal residence is not necessarily unusual, especially if the administration of the estate is prolonged. Nevertheless, since the loss is only appropriately deductible if the estate can prove that the property was converted to income producing property, estate returns should be examined on a case-by-case basis to determine whether the estate has converted the personal residence to rental property.

This paragraph certainly implies that the personal residence must be converted to rental property in order for the loss to be deductible. But it doesn't say that explicitly, and it doesn't address the question of whether the residence can be converted to income-producing property without being converted to rental property.

The distinction is huge. In the case of a gain, the sale of rental property is ordinary income. But gain on the sale of investment property would benefit from capital gain tax treatment...

Arguing that the property was held as an investment by the estate might be difficult, particularly since the value of the house was apparently falling, and not increasing.

I'm afraid I don't have a real answer for you. I'm just kind of thinking out loud, and kicking this around. SCA 1998-012 is over ten years old, and seems to address a very specific fact pattern. I realize that the underlying law hasn't changed very much in the last ten years, but I'm still not convinced that SCA 1998-012 is reliable guidance.

The question seems to be:

Even if the residence is not converted to rental property, does it cease to be the personal residence of the decedent, and become a more generic capital asset of the estate, after a certain period of time during which it stands vacant?

BMK

[origun]

Estate sale of residence

Thanks, Koss, for your reply. I appreciate your analysis. My reading of SCA 1998-012 really threw me for a loop as I have heard (unofficially) from many people that there should be no problem taking this loss if you have appropriate documentation such as appraisal. (Knowing the real estate market in this area, I don't question the loss. My home would have had a similar loss if I had wanted to sell during this time period.) I know of several CPAs who routinely take this capital loss and estate lawyers spread the word to their clients that it can be done when filing 1041s and K-1s.

From my search on this forum, I have read that others have done so. I'd be interested to know if anyone who has done so has been questioned by the IRS.

[Roland Slugg]

FWIW I come down on the side of such a loss NOT being deductible if the decedent's home was simply owned for a period of time before it was finally sold. It's really no different from a car, furniture, or any other personal, capital assets of the deceased. Once a person dies his personal assets don't automatically convert to investment property. Affirmative steps must be taken, of which the most obvious in the case of real estate would be renting it out. Simply holding it doesn't make it investment property.

Btw, what's this in an above post about the gain on sale of rental property being ordinary income? That's news to me.

[Gene V]

TTB 7-8

Sale of Rental Property

For MACRS nonresidential real property and residential rental
property that has been depreciated using the straight-line method,
gain attributable to depreciation is unrecaptured Section 1250
gain subject to a maximum tax rate of 25%. Any remaining gain is
subject to regular capital gain rates.

[origun]

Property in question was never rented

In response to Gene V, the residence was never rented. It was personal residence of the deceased for many years, was the primary asset in the estate, was put up for sale soon after death and was finally sold 2 years after death by the estate at a loss of close to $100k compared to appraisal at time of death (after being empty for 2 years) . So...whether it was personal property or investment property is the question I'm trying to figure out.

Do any of you take the loss on the 1041 and pass on to beneficiaries on K-1? I feel a little uneasy about doing this as I tend to be a bit conservative on questionable issues... but know it is done quite commonly. The PR of estate was told by estate lawyer that it could be done...but don't know how much he/she knows about tax law. I have done returns for 13 years and am an EA but primarily do individual returns and have only done one estate return on my career so don't have much personal background on this topic.

Thanks for any input any of you very knowledgeable preparers can give!

[Gene V]

Inherited property

Here is a link to some earlier discussion on the sale of inherited house,
This might give you the answer.

http://www.thetaxbook.com/forums/showthread.php?t=7327

[origun]

Thanks Gene

Thanks for the link to a prior discussion. I had done a search previously but guess I didn't phrase my search well as didn't come up with this thread.

I really appreciated the link to Pub. 559--I really needed some IRS phraseology to support taking the loss. And the references made by several forum participants to "intent" were helpful. The family of the deceased certainly had no intention of living in the house (and never did) and just wanted to sell it asap for as much money as possible. Unfortunately their timing wasn't good as the local real estate market fell apart just when the house was put up for sale.

So...my present inclination is to take the loss but warn them about the 1998 IRS memorandum. With the present housing market, there could be lots of losses like my client's so maybe this is something the IRS will be auditing more.