Net Operating Loss

[Harvey Lucas]

My client sold a rental house in 2009 for a $119,000 loss.

He has wage income of $60,000.

He sold the rental on Jan 1st 2009, so he has no rental income or expense for 2009.

He has no other income or expenses.

His 1040 line 22 total income is then negative $59,000.

The $119,000 loss from sale of the rental house is a section 1231 loss.

My understanding is that if you have a net section 1231 loss such as this, the loss is treated as an ordinary loss for deduction purposes, ie, the entire amount can offset other current year income.

It is also my understanding that since this loss is considered "ordinary", ie, not a capital loss, that it is included in the computation for a net operating loss carryback or carryover.

My client can file an elction and carryover a $59,000 NOL to future years.

If my client has any capital gains in the next 5 years, those gains will be taxed as ordinary income up to the $119,000 amount, and any excess amounts over $119,000 will be taxed at capital gains rates.

Any problems with my assumptions here?

Thank you,

Harvey Lucas

[Davc]

If my client has any capital gains in the next 5 years, those gains will be taxed as ordinary income up to the $119,000 amount, and any excess amounts over $119,000 will be taxed at capital gains rates.

Any problems with my assumptions here?

Yes, It's capital gains that are affected by net unrecaptured 1231 losses, it's only 1231 gains.

[appelman]

Harvey's assumptions seem ok to me.

DAVC: could you please clarify what you are trying to say?

[Davc]

Oops! Should have been:

Yes, It's NOT capital gains that are affected by net unrecaptured 1231 losses, it's only 1231 gains.

Or put another way. If a transaction starts on schedule D, then any gain is not 1231. If it flows from 4797, then it is 1231 and could be taxed as ordinary income.

[Kram BergGold]

I think I disagree

The 2009 loss creates an NOL which you will choose to carryforward. If there are capital gains in future years these will create either short term or long term gains. The NOL will only come into play to reduce any and all income on Form 1040. It has no impact on Schedule D.

[Davc]

Karen, see TTB CD 6-12.

Section 1231—Special Treatment for Gains and
Losses on Sale of Business Assets
IRC Section 1231 provides the best of both worlds on the sale of
business assets and residential rental property.
Gains are treated as capital gains subject to favorable tax rates.
Losses are treated as ordinary losses (not limited to the annual
capital loss limit of $3,000 per year).
Mechanics. If the total of all gains from sales of business property
exceed the total of all losses, all transactions are considered
to generate capital gain or loss. If the total of all gains does not
exceed the total of all losses, all transactions are considered to
generate ordinary income and loss.
Nonrecaptured net Section 1231 losses. If cumulative
net Section 1231 losses have exceeded Section 1231
gains for the prior fi ve years, the difference is
treated as ordinary income.
Example: Andrew owns a graphic arts company and
has the following net Section 1231 gains and losses:
Tax Year Net §1231 Losses Net §1231 Gains
2006 $8,000 $ 0
2007 $ 0 $ 0
2008 $ 0 $5,250
2009 $ 0 $4,600
In 2008, Andrew reports the entire gain of $5,250 as ordinary income.
In 2009, Andrew reports the $4,600 gain as $2,750 of ordinary income
and $1,850 capital gain ($8,000 – $5,250 = $2,750 nonrecaptured net
Section 1231 loss).

[appelman]

If I can summarize all of this...

It still sounds like Harvey's conclusion is right.

[Davc]

It still sounds like Harvey's conclusion is right.

Not quite. Only 1231 gains result in ordinary income because of net unrecaptured 1231 losses. If you have a gain on sale of stock or personal property, it remains capital.

[appelman]

Absolutely right!

I missed that in the original post.