Yahoo Finance published an article on the tax implications of selling your house at a loss. FML’s Lisa White was one of the tax professionals who gave advice to people on what they need to know about navigating the tax code when deducting real estate losses.
The first excerpt where Lisa is quoted concerns conversions and Section 1231 property:
Ready for more complexity? You’ve got it — especially if you’re selling a home that started as a personal residence that later became a rental. This use change can significantly impact how the IRS treats the sale and any losses derived. Lisa White, a CPA with tax advisory firm Fiondella, Milone & LaSaracina LLP, offered an example to illustrate.
Imagine you bought a condo when you were single. Later, you get married and move into a new home, then decide to rent out your condo. When you eventually sell your rental condo, it’s no longer a personal-use property. It’s now considered business-use real estate under Section 1231 of the IRS tax code.
Business-use real estate refers to property used for trade or business purposes. That includes rental homes you lease to generate income. To qualify as a business-use property, a property must be used primarily for business purposes (a consistently revenue-generating rental) at the time of sale.
Section 1231 rules state the following about capital gains and losses:
— Properties sold at a gain. Gains get taxed as long-term capital gains (more favorable).
— Properties sold at a loss. Losses could be classified as ordinary losses, which can offset ordinary income without being subject to the $3,000 annual capital loss cap.There’s one important caveat, however. “The basis for that loss would be the lesser of the adjusted basis of the property or the fair market value at the time you started using it as a rental,” said White.
So, if you convert a home to a rental, don’t forget to document both values at the time of conversion so you can use the most favorable value when it’s sold.
The second excerpt is about how documentation is everything when claiming real estate losses:
If you plan to claim any kind of real estate-related loss, you’ll need to back it up with solid documentation.
“You’ll definitely want to have a copy of your closing statement — both for the time of purchase and the time of sale,” said White. The purchase closing statement helps establish your initial cost basis, which the sale statement verifies your proceeds and transaction costs.
You should also keep additional documentation, including:
— Receipts for capital improvements (e.g., roof replacement, new A/C system, home additions)
— Depreciation schedules for rental properties
— Appraisals or market value estimates, if you convert a home to a rental“If the IRS does come knocking, it’s going to be up to you to prove where that [cost] basis number came from,” White said.