Have a Tax Question? Ask a Tax Expert
Hi and welcome to Just Answer!
You can deduct a loss on the sale of property you acquired for use as your home but changed to business or rental property and used as business or rental property at the time of sale.
You need to report the sale transaction on your tax return. To do so - you need to determine the basis of the property.
As the property was purchased - that is your original basis. However, if the adjusted basis of the property at the time of the change was more than its fair market value, the loss you can deduct is limited.
The basis should be adjusted by purchase expenses, improvement expenses, depreciation for the time it was rented, etc. Your loss is calculated as (selling price) - (adjusted basis).
If you dispose a rental property – you report the sale transaction on the form 4797 - Here are the form and instructions - www.irs.gov/pub/irs-pdf/f4797.pdf www.irs.gov/pub/irs-pdf/i4797.pdf
Because a residential rental property is section 1250 property – that is not a capital loss – but a business loss and is fully deductible on your tax return.
Please verify if the debt was forgiven for mortgage balance.
Please also verify if you had rental losses carried over from previous years.
Ok. I think I follow so far. Because it was a short sale, the mortgage was forgiven. The total forgiven debt was $142,000 and the mortgage agreed not to pursue collection as a part of the short sale agreement. I have not received a 1099 for this yet, but I expect that I probably would?? I have been deducting the rental losses on my tax returns each year since I started renting the property. The rental revenue did not cover the expenses and depreciation. Also, I did not have any rental income for 2010 since the property was for sale and I could not get a new tenant.
Could you also explain the adjusted basis calculation? I purchased the house at $440K and sold the house for $210K as a short sale. The total depreciation and improvement expenses was around $50K.
I suggest IRS publication 527 - www.irs.gov/pub/irs-pdf/p527.pdf
When you change property you held for personal use to rental use (for example, you rent your former home), the basis for depreciation will be the lesser of fair market value or adjusted basis on the date of conversion.
To figure your property's basis for depreciation, you may have to make certain adjustments (increases and decreases) to the basis of the property for events occurring between the time you acquired the property and the time you placed it in service for business or the production of income. The result of these adjustments to the basis is the adjusted basis.
You must increase the basis of any property by the cost of all items properly added to a capital account.
Add to the basis of your property the amount an addition or improvement actually cost you, including any amount you borrowed to make the addition or improvement. This includes all direct costs, such as material and labor, but not your own labor. It also includes all expenses related to the addition or improvement.
Do not add to your basis costs you can deduct as current expenses. For instance - you can deduct the cost of repairs to your rental property – these are not added to the basis.
Depreciation that you deducted while the property was rented should be subtracted from the adjusted basis.
Assuming that at the time the property was converted to rental its FMV was more than $440,000 (purchase price) – your estimated depreciation $440,000 *4 years /27.5 years (depreciation period for residential rental properties) = $64,000.
So your adjusted basis is estimated as $440,000 - $64,000 + $50,000 (improvements) = $426,000.
Also the forgiven debt of $142,000 will reduce the basis.
So your basis will be $426,000 - $142,000 = $292,000
Because the property was sold for $210,000 - your estimated loss is $82,000.
Great. This is making sense to me now. So what happens if the mortgage holder (Bank of America) does not issue a 1099 for the forgiven debt? Am I still obligated to report it to the IRS or should I exclude this on my tax return.
I spoke with Bank of America today (they held the mortgage on the property) and they told me that there were no year end tax documents for the property on file and that they would not be issuing any documents for the sale except the 1099-S which I already have. The 1099-S shows the amount of $210,000 which was the sale price on the property.
If the bank forgives the mortgage outstanding - they are required to issue the form 1099-C As they will not issue the form - that most likely means - your debt is not forgiven (at least in 2010) and so far - you are liable for the balance. You will use $210,000 from 1099-S as the sale price for your reporting.
Please let me know if you need any help or clarification.
Ok. I think I've got it. One more question on settlement of credit card debt. I settled with American Express on some credit card debt. The total was around $25,000. I would like to try and claim insolvency so that I don't have to pay taxes on this. I have received 1099-C from American Express on this account. How do I go about making or documenting an insolvency claim for cancelled debt?
To claim insolvency exemption - and not include the cancelled debt into your taxable income - you need to add the form 982 to your tax return - www.irs.gov/pub/irs-pdf/f982.pdf - The information on the form 982 is to proof your insolvency.
From reading this and publication 4681, it appears that the insolvency calculation would include the asset & liability on my rental property. Is that correct? Could insolvency also be applied to the forgiven debt on the mortgage from my rental property?
Yes - that is correct - all your assets and liability at the time the debt was forgiven should be included.
You also correct – that you may use insolvency exemption for the forgiven debt on the mortgage from your rental property, however – you still need to reduce the basis by that amount.
Great. Thanks for all your guidance!
See Part II of that form - Reduction of Tax Attributes for adjusting the basis.
Sorry - I was not able to answer your follow up question.
You asked: have only owned the house since 2005. The original purchase price was $440K, plus improvements of $25K, less depreciation of around $50K which would be a tax basis of $365K. The property sold for $210K. The net loss would be $155K, correct?
That is not correct - your basis should be reduced by the amount of canceled debt - that what is called Reduction of Tax Attributes for adjusting the basis.
So your basis will be $365K - $188 = $177
and you will have a gain of $33k which will be taxed up to 25% as depreciation recapture.
Sorry - that is not as good as you thought, but your mistake would be more costly.
yes, Under federal tax law someone who has a canceled debt (even a credit card debt) MUST report that as income the following year when they do their taxes.
Stupid or not it IS the current tax law.
BotXXXXX XXXXXne...Uncle Sam wants his share....
If this does not answer your question please let me know.
If this answers your question please click the green ACCEPT button and leave Positive Feedback
Insolvency is another work for bankrupt. whether or not you ARE or even if you CLAIM insolvency (bankrupt) you HAVE to include the canceled debt as income when/if you file taxes again.
I appreciate Mr. Adamo for timely and valuable response.
The reason I trigger this subject again because I saw in your another thread that you have incorrect impression that you may double dip and have forgiven debt exempted from the income and claim NOL resulted from the sale without reducing your basis.
If you do so - that would be easy discovered by the IRS and penalties will be substantial.
Please see for reference - http://www.irs.gov/taxtopics/tc431.html
Generally, if you exclude canceled debt from income under one of the exclusions listed above, you must also reduce your tax attributes (certain credits, losses, and basis of assets) by the amount excluded. You must file Form 982 (PDF), Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), to report the exclusion and the corresponding reduction of certain tax attributes.
Sorry for disappointing you.
Could we recap all of this? Let me see if I have this correct.
Purchase Price of Rental Property - $440,000 in 2005. Started renting the property on 1/1/07. I added improvements of $10K to the property and deducted depreciation of $39,753 for 2007-2008-2009. The starting basis would be $410,247 for the property.
The house sold for $210,000 on 10/28/10. The net loss at that point would be $200,247. The bank mortgage cancelled debt of $163,176 which would result in a net loss of $37,070. I should be able to reduce my net income by $37,070, correct?
In addition, I would be able to deduct depreciation for 2010 up until the property was sold and also claim $21K in closing costs on the sale of the property. Is that also correct? If so, my loss would be in the area of $68,000.
Is the loss deductible from my net income directly or is there a limit on the capital loss? I'm not sure if this applies and would like more information on this.
As a raw estimate - you are correct.
You may deduct depreciation for 2010 - but that will reduce your basis by the same amount - so overall there will not be any difference.
You may add SOME of your closing costs to the basis. Part of closing costs for instance related to real estate taxes and mortgage interest may not be added to the basis.
After you determine the adjusted basis - you will determine your gain/loss on that sale.
The loss resulted from the sale of rental property is not treated as a capital loss and you may deduct it without $3000 limitation.
Passive losses on a rental property that were previously disallowed - are fully deductible at the time you are selling your rental property.
You should use the form 4797, Sale of Business Property - http://www.irs.gov/pub/irs-pdf/f4797.pdf
Reporting procedure is described in the IRS publication 334 - http://www.irs.gov/pub/irs-pdf/p334.pdf - see page 23.