Sch E losses carry forward or gone?

[Possi]

I hope I didn't mess this one up...

My clients had 2 rental properties carrying large losses forward. Last year, I deleted them, losses and all, because they had to walk away from them financially. They had not paid any expenses and had no income from the 2 properties.

This year they are going into bankruptcy.

If I had not deleted those 2 rental properties (they have one more that is doing ok, locally) would the losses have carried forward until gone?

In retrospect, I think I should have just stopped depreciation, everything else would have been zeros, and keep them on the tax return. If so, should I amend last year and carry those losses forward?

[BOB W]

Schedule E losses are generally "suspended losses" due to income limitation. These losses are released if the property is disposed of.

How this fits your problem, I don't know.

[Possi]

Thanks

Schedule E losses are generally "suspended losses" due to income limitation. These losses are released if the property is disposed of.

How this fits your problem, I don't know.

Maybe I read that last year and that's why I let it go. I'm relieved. Thanks~

[Nashville]

They're Still Around

You can't just stop depreciating these properties. Even if the depreciation creates a non-deductible loss. The depreciation actually creates a LARGER non-deductible loss, meaning a larger loss which can be carried forward. Even if you stop taking depreciation, the situation is still "depreciable" so long as the property is being used (or even attempted to be used) for rent.

The non-deductible losses are "pooled" and allocated to all loss properties in proportion to their prior year basis. The losses must be kept in proportion when allocating rather than attempting to assign specific losses to specific properties.

The losses may be recovered in three ways:

1) By selling the properties. The losses increase the basis so the entire basis gets reported upon sale. This is true even if the sale itself is at a loss.
2) By operating at a profit. All profits are "pooled" and applied similarly to the losses FIRST before reporting a profit.
3) By enduring a deductible loss formerly disallowed in previous years because taxpayer's income was higher than phaseout but now his situation is much lower. The $75K-$100 phaseout may be tested every year, and if it can accommodate the accumulated losses, then the previous losses can be released.

Short answer is your clients' formerly nondeductible losses are still there.

[BOB W]

Maybe I read that last year and that's why I let it go. I'm relieved. Thanks~

By "released" I mean they can be used to offset any gains upon disposition....

And as Nashville said, If income goes below income thresh holds the carryforward losses are reevaluated and any allow losses are "Released" against current income.

[Possi]

Amend last year?

Last year, he no longer owned the properties. He had to stop pouring money into them, so he let them go. (Hurricanes had a play in those expenses as I recall)

So, they weren't sold.

So, depreciation should have been stopped because he was out of the rental gig.

BUT, I should have kept the property listed on the Sch E so that the losses would carry forward.

Do I need to amend last year and put them back on the Sch E? Seems like I could just enter the carryforward losses somewhere and not go BACK and re-do the return.

I don't know why I just deleted them.. I must have been looney.

[Lion]

Bankruptcy Estate

Are the properties going into the bankruptcy estate to be dealt with there? So that your client no longer owns them?

[Possi]

No

He no longer owned them in 2008. He gave them away, basically.

[Possi]

No longer his property

You can't just stop depreciating these properties. Even if the depreciation creates a non-deductible loss. The depreciation actually creates a LARGER non-deductible loss, meaning a larger loss which can be carried forward. Even if you stop taking depreciation, the situation is still "depreciable" so long as the property is being used (or even attempted to be used) for rent.

The non-deductible losses are "pooled" and allocated to all loss properties in proportion to their prior year basis. The losses must be kept in proportion when allocating rather than attempting to assign specific losses to specific properties.

The losses may be recovered in three ways:

1) By selling the properties. The losses increase the basis so the entire basis gets reported upon sale. This is true even if the sale itself is at a loss.
2) By operating at a profit. All profits are "pooled" and applied similarly to the losses FIRST before reporting a profit.
3) By enduring a deductible loss formerly disallowed in previous years because taxpayer's income was higher than phaseout but now his situation is much lower. The $75K-$100 phaseout may be tested every year, and if it can accommodate the accumulated losses, then the previous losses can be released.

Short answer is your clients' formerly nondeductible losses are still there.

Is this true if he no longer owns the property? He did not own them in 2008. He gave them away. Did not sell them, did not own them. That's why I thought the losses would not carryforward anymore.
I have never come across this before and don't want him to lose out on reducing his income for the disallowed losses that he couldn't take before.
But, I don't see how he can still take the losses if he no longer owns the property.
I'm so confused.....

[Gretel]

Possi, he positively cannot carry forward or take losses for something not owned any longer. The year he last owned the properties is the only year to take losses on disposition. What I don't know is if he were eligible to take these losses if he gave them away. A gift is still a disposition but I don't know the rules.

[New York Enrolled Agent]

Possi, he positively cannot carry forward or take losses for something not owned any longer. The year he last owned the properties is the only year to take losses on disposition. What I don't know is if he were eligible to take these losses if he gave them away. A gift is still a disposition but I don't know the rules.

With exceptions such as death of a taxpayer, losses on dispositions of passive activities will be recognized only in a FULLY TAXABLE transaction. See §469(g)

[Possi]

In bankruptcy

Possi, he positively cannot carry forward or take losses for something not owned any longer.

Thank you for that defining statement!

I found out today that both properties are in the bankruptcy papers. While he walked away from the properties and had nothing to do with them in 2008, he was still legally financially responsible for them. No income, no expenses since 2007. He paid nothing and had no rental income. So, he really did not own them as rental property. I do not believe he should be allowed to take those losses.

It is a shady area, for me anyway.