Sale of rental property using land contract at a loss

[LMathey]

Client purchased a rental property in 2012 for $48,852. Depreciation taken was $12,246. Sales price is $35,000. Since the property is being sold at a loss of $1,606 I cannot report it as an installment sale. Therefore, I am reporting the loss on Form 4797.

My question is: What happens if the purchaser walks away and does not fulfill the contract?

[Burke]

By contract, I assume you mean the seller is holding a note or mortgage? What does the contract say? Does the property revert back to the original owner? Usually, they can repossess it. In the meantime, the seller reports the interest received each year. If seller has to foreclose and repossess the property, he can sell it again.

[LMathey]

Yes there is a contract and the property reverts to the seller. At that point they could resell it. However, they will have taken a loss this year (2016) which assumes that the buyer will perform. Do they have to recover any of the loss? There is a recorded mortgage and they provided the buyer with an amortization table and a statement of interest paid in 2016. They also are reporting as sell-financed mortgage interest on their tax return.

[Roland Slugg]

Do they have to recover any of the loss?

By that I assume you mean, does the seller have to report as income in the year repossessed any of the loss deducted in the year of sale? No, he does not.

If he does foreclose and reacquire the property, the seller's basis in the repossessed property will be equal to his adjusted basis (i.e. the principal balance) in the note he was carrying immediately before the foreclosure, plus the costs of the foreclosure.

[LMathey]

By that I assume you mean, does the seller have to report as income in the year repossessed any of the loss deducted in the year of sale? No, he does not.

If he does foreclose and reacquire the property, the seller's basis in the repossessed property will be equal to his adjusted basis (i.e. the principal balance) in the note he was carrying immediately before the foreclosure, plus the costs of the foreclosure.

Thanks, that makes sense to adjust basis for the next sale. I appreciate you taking time to answer.