I am a resident of, and own a primary residence in the state of Wisconsin. On March 5, 2001 I purchased a condominium in Iowa for $191,000. My elderly parents have lived in the condo rent free since its purchase although they pay the annual real estate taxes. I pay the mortgage and the property is titled in my name subject to the mortgage.

In 2011, I defaulted on the mortgage and the bank started foreclosure proceedings. However, I was able to refinance the property with a non-related third party limited liability company (LLC). The LLC purchased the condo from me for the mortgage balance of $141,500 and simultaneously sold the condo back to me for $152,000 ($141,500 mortgage balance plus facilitation fee and transaction costs) in exchange for a $152,000 land contract. I received a 1099-S for $141,500 and need to determine how to report the transactions.

For purposes of gain or loss calculations, my position is that the condo is either a second home not for personal use or an investment property. Because I have never charged my parents rent, it appears that the dwelling unit does not meet the safe harbor Qualifying Use Standards in Rev. Proc. 2008-16, Section 4.02. Although the safe harbor provided in this revenue procedure applies only to the determination of whether a dwelling unit qualifies as property held for productive use in a trade or business or for investment under Section 1031, it appears that the IRS might take exception to the investment property classification for the condo. It certainly precludes the transaction for being reported as a like-kind exchange under Section 1031.

It seems to me that this transaction is the equivalent of a wash sale of substantially identical securities. Under the wash sale rules, the loss would be denied and the old basis would continue until the security is sold in a non-wash or non-short sale transaction. Unfortunately, I can’t find any authority to take this position for real estate.

The capital gain and loss provisions apply to the sale or exchange of a capital asset (Code section 1222; Reg. Section 1.1222-1). In the case of real estate, a sale or exchange occurs on the earlier of the date of conveyance or the date when the burden and benefits of ownership pass to the purchaser. It could be argued that the “burden and benefits of ownership” never passed to the LLC because the LLC conveyed the property right back to me subject to the land contract, which was for the old mortgage balance plus transaction costs. Therefore, the substance over form of this transaction is at the beginning and end of the transactions, I still owned the condo subject to a mortgage. Therefore a sale did not take place. Perhaps it’s an exchange. If so, how do I report it?

I could also argue that because the LLC has a mortgage note receivable subject to foreclosure rights and did receive a minimal profit from their transaction fee the “burden and benefits of ownership” did pass and a sale transaction should be recorded. If so, I return to my wash sale comments above. It seems counterintuitive that a capital loss would be recorded and reported on Schedule D of the tax return.

My father has died and I will soon be moving my mother to an assisted living facility and selling the condo. Therefore, my concern is reporting a $50K capital loss in 2011 and a $50K to $60K gain in 2012 on the same property. If reported as a sale resulting in a capital loss in 2011; the capital loss carry forward will equal the step-down in basis from the original purchase in 2001 to the sale in 2011 and the capital gain taxes of the future sale will essentially be the same as if only one transaction took place. However, I’m concerned about the IRS trying to disallow the loss resulting in original loss of basis and no capital loss carryover to off-set the gain.

It seems to me, the best way to report this transaction is to: (1) report the $141,500 proceeds on Schedule D to reconcile with the 1099-S; (2) report the $191,000 basis in the property on Schedule D; and (3) show zero gain or loss on Schedule D and attach a statement explaining why the loss was not recognized in 2011 and why the $191,000 basis carries forward on the property. If you agree, I could use some help on the wording of the explanation or a better way to report the transaction. If you disagree, how would you report the transaction? I welcome your thoughts on how to report this transaction. Thanks.

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State/Country relating to question: Iowa

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