Short Sale at a loss

[NotEasy]

Taxpayer had a short sale in 2010 that the sale price is less than the loan. So the lender sent him a Form 1099-C for the difference. The amount is about $150,000. This debt cancellation amount is considered ordinary income.

But the property is a rental property and the taxpayer has also sold the property at a loss in the short sale. The total loss is about $200,000. It is considered capital loss though so the maximum deduction is only $3,000 each year.

To cut a long story short, the taxpayer has to recognize the full amount of debt cancellation, $150,000, this year. But he can only claim $3,000 of the capital loss this year, even though the total loss is $200,000.

Am I correct?

[erchess]

Why is

a rental house a capital asset instead of a business asset? I would have reported the sale of the rental house on F 4797 which would have generated an ordinary loss. Maybe you or someone else knows better than I do though.

[Gary]

I agree

And it might generate an NOL. See my post earlier.

Gary

[S T]

See prior posts

Agree, The rental transaction should be reported on 4797
However, you could produce some income depending on the depreciation.

Sandy

[DonB]

Imho

I believe a rental building is a capital asset and you have it correct, $3k per year write off. Did you explore the exceptions to COD income? Insolvency?

[oceanlovin'ea]

4797

Rental property is sold on 4797. When taking classes rental property was always the example that was used to show sale of business property. It showed the land sale, house sale and furnishings (if any).

I thought that when I first read the question and waited to see what others said. I vote for 4797 sale.

Linda, EA

[Gary2]

If only it were that simple.

As said, it must go on 4797. Assuming this is a building held more than a year, the land must be treated separately from the building. Get an appraisal, or possibly assessors info. In theory, there could be a gain on the land and loss on the building or vice versa. If there are any other depreciable items (e.g. appliances), they might need to be treated separately, too.

Assuming everything works out to a loss, I'd expect it all to be section 1231 ordinary loss, fully deductible on line 14 of 1040.

[Koss]

Not a capital asset

Without directly addressing the cancellation of debt, I'm going to weigh in on the question of the tax treatment of gain or loss on the sale of a rental property.

Rental property is not a capital asset. It is an asset that is used in a trade or business. The sale generates ordinary gain or loss, and it should be reported on Form 4797, just like the sale of an automobile that is used 100% for business.

Rental real estate is a trade or business. It is certainly different from other businesses, in that it is subject to the passive activity rules, and other special considerations, but it is definitely a trade or business.

If I replace appliances that are in the rental property, and then sell the old ones, at a garage sale or on Craigslist, the sale of those used appliances is reported on Form 4797, and it generates ordinary gain or loss. Yes, you have to account for the depreciation. But that's my whole point. The sale of the house itself is no different.

Rental property is not a capital asset.

Now, if I'm holding vacant land as an investment, that's a whole different conversation.

I respect dissenting opinions, but it's going to be pretty hard for anyone to convince me otherwise on this particular point. The term capital asset is defined by exclusion. The Internal Revenue Code doesn't tell us what a capital asset is; it tells us what it is not. Assets used in a trade or business are not capital assets. There's a little bit more to it than that. But to me it's clear that renting property is a business activity, whether you are renting houses, offices, power tools, or tuxedos. The assets that you are renting, whether they are real property or personal property, are not capital assets.

Perhaps the confusion arises out of the fact that rental real estate is often referred to as investment property. In the world of real estate investors, financial planners, and mortgage lenders, it is certainly true that rental real estate is an investment. But in our world, rental property is not "property held for investment." It is not the same as holding shares of stock, or gold coins, as an investment, where you hold it in the hope that its value will increase. Yes, people buy real estate as an investment, with the hope that it will appreciate. But the flow of rental income changes the nature of the asset. Rental income is not the same as investment income such as interest and dividends.

BMK

[Koss]

Okay, wait a minute... [LOL]

I stand by my assertion that rental property is not a capital asset.

But as I look at Form 4797...

Gain on the sale of a business asset that was held for more than a year, in most cases, will flow to Schedule D, and qualify for capital gain tax rates.

Loss on the sale of a business asset, regardless of the holding period, appears to be treated as an ordinary loss.

Right?

BMK

[WhiteOleander]

I stand by my assertion that rental property is not a capital asset.

But as I look at Form 4797...

Gain on the sale of a business asset that was held for more than a year, in most cases, will flow to Schedule D, and qualify for capital gain tax rates.

Loss on the sale of a business asset, regardless of the holding period, appears to be treated as an ordinary loss.

Right?

BMK

Yes, your description has been my understanding of rental property sale all these years.

[DonB]

Stand corrected

LT gain flows thru 4797 to D and gets CG treatment. Loss to 4797 pg1 part 1 and is ordinary loss. Haven't seen a loss forever and jumped to a wrong conclusion.