Wasted Tax Benefit

[Snaggletooth]

A client (former Army general) has been a high income person for most of his career, and is now retired.

Has four houses, and only one of them can be a principal residence. In 2010 they buy an expensive house in Florida and rent it out to a nurse practitioner for 10 years. During this time some $117,000 in rental losses accumulate because they couldn't be taken with incomes always over $150,000. So by 2020, if they decide to sell, they get to claim the suspended losses in the year of the sale. OK.

However, that's not what happens. The house is high-value property and they decide to move into it in 2020. This home is now their principle residence, and to the extent of my knowledge, there has never been an opportunity to deduct the $117,000 in suspended losses.

They don't ever plan to live in any other principal residence. Should they live until they die, their beneficiaries will have the house at FMV. as of date of death.

If you have read through this situation thus far, I would be grateful if anyone can figure out a way to take advantage of the $117,000 suspended losses. Assume they never sell.

Thank you, Ron J.

[terryats]

You said your client has other rentals, and if they sell them, the suspended losses can be used to offset any capital gains. You don't have to use suspended losses on the property that created them.

[terryats]

As a follow up your client would have to consider his rentals as a single business activity

[Snaggletooth]

You said your client has other rentals, and if they sell them, the suspended losses can be used to offset any capital gains. You don't have to use suspended losses on the property that created them.

The client has four homes, none of them rented. If I said otherwise, I apologize. He lives in two of them, one for cold weather, another for summer. Only one of them can qualify for his primary residence.

One of the properties is getting ready for sale, but it is not the one with the suspended losses and has never been rented.

[Rapid Robert]

"As a follow up your client would have to consider his rentals as a single business activity"

I had to look up in TheTaxBook to double check, but no, it is not necessary to do any grouping election in order to deduct suspended passive losses against passive income. It does not have to be from the same property . In fact, "Losses that are not allowed under these rules are allocated among the taxpayer’s passive activities and carried over to future years." So susended losses do not stay stricly with the property that generated them, if more than one passive activity. (which you said yourself, in the previous post).

The purpose of grouping is to make it easier to avoid passive classification by reason of material participation. It is not to allow offsetting of passive loss against passive gain, that is already automatic.

Back to the OP, no there is no way to use the suspended losses if there is no other passive income and they never make a complete disposition of the property. However, what difference does it make? Assuming they charged FMV rent, the suspended losses are going to be mostly due to depreciation, which was never a cash expenditure. If they sold the house, the adjusted basis for depreciation would generate gain that would simply by offset by the loss, so even in the "normal" situation, the suspended losses aren't really a huge tax benefit. The heirs getting an adjustment to FMV at death is a far greater benefit.

[kathyc2]

I'm guessing most if not all of the 117K suspended loss is from depreciation. If so, and they were to sell it, the only tax savings would be if regular marginal rates are more than the 25% max 1250 rates.

Housing prices were in the toilet in 2010, so it wouldn't be surprising if the selling price now would be double what it was in 2010. Selling might produce some huge gains.

During the 10 years it was rented, likely most of the cash they received for rent was tax free income. The renter was effectively paying the RE tax, insurance, interest (if applicable), etc. Without rent income they would be able to take a deduction for these items.

[Snaggletooth]

Kathy and RR:

Your responses are appreciated. Yes the depreciation taken is the major portion of the suspended losses. Bought in 2010 for $450,000, I suspect today's FMV is over $1MM. The property taxes alone for this residence is over $20,000, and for all properties over $30,000. So just the property taxes on this home busts through the SALT ceiling.

RR there were no other rental properties, so allocating the suspended losses have no other properties to share with. And you are correct: the potential beneficiaries get a much better deal with the stepped up basis than the $117,000.

The discussion leads me to believe that unless something changes, the $117,000 benefit will be up in smoke.

[kathyc2]

The discussion leads me to believe that unless something changes, the $117,000 benefit will be up in smoke.

Well, cry me a river that someone with a taxpayer funded pension income is too high to take a tax deduction for something they didn't have an actual loss on.

[Snaggletooth]

Yes Bleeding Hearts unite!!

And the point is correct: there is no real economic loss at all, and this taxpayer, with four properties in three different states absolutely will not ever measure the impact on his wealth.

Yet I do try to make every effort to reduce taxes as much as possible for my clientele. And over the years, the customers are getting wealthier and wealthier, as more and more taxpayers succumb to the higher standard deductions and the "free" turbotax ads. (You know, the ones that tell you to buy their software and you will instantly become as smart as a CPA).

It should be our mission to save as much tax money as we can for our customers, without resorting to cheating. The preparers are out there who will turn a blind eye to unreported income, lying about dependents, adjusting earned income to maximize EIC, etc. I wish the IRS would audit more of these charlatans.