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Move Out for 2 Years to Take a Loss

By The TaxMan

Services for Real Estate Pros with Self Employed

November 06, 2007 05:11 AM

Many people have had to sell their homes lately, and often at a loss.

I feel for the families who have had to work hard to purchase their only property, only to be forced back into a lifestyle of rent.

For those who still own their property, if it appears you must sell it and take a loss, I offer this advice:

You cannot claim a loss from the sale of personal residences, but you can deduct losses from rental property sales.

If it looks like you are going to be taking a loss on your primary home, consider moving out and renting out the property before selling it.

The best advice would be to hold off on selling the property until the market gets better and you can actually sell for a profit, but you shouldn’t hold your breath if it looks like you’re going to lose more money.

It may be more beneficial to move out of your home and rent it out before selling, so you can actually deduct the loss from the sale.

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Chad Baird

Re/Max Spirit - Dayton, OH

The problem though is that most of the sellers can not affort the rent or the new mortgage and to pay the morgtage on the rental property. The mortgage company will have an issue with the mortgage holder renting the property as well. It then becomes an investment property, not a personal mortgage. The mortgage was issued for personal use and makes the not callable by the lender.

Nov 06, 2007 06:53 AM

The TaxMan

Self Employed - Oakland, CA

Unfortunately, that is the dilemma. Take this situation:

The homeowner obviously cannot afford the mortgage on his own own, as his monthly cost is $2000 (say the mortgage is $2k), and he cannot sell without taking a loss .

Assume the home can be rented out for $1800.

I would say rent it out for 1800, and find a place for $1500. Now the homeowners monthly cost is $1700.

That way you still have ownership, still making payments, and your monthly cost is lower. And after taxes, you will get to claim a loss on the rental property, so that should help out substantially.

Obviously, this is a sacrifice, and who knows if a couple thousand buck will really help you out in the long run...

But for some people, this may be the difference between losing a lot of money and living comfortably.

Nov 06, 2007 08:14 AM

Nick M.

Certified Residential Appraiser- West Palm Beach Real Estate - West Palm Beach, FL

Realtor-Appraiser in West Palm-South Florida Real Estate Appraiser

Hey Tax Man, are there any specific time requirements or other things that one should be aware of? i.e. the property must be rented for X amount of time, before it's considered a rental for tax purposes.. also, would you have to remove the homestead exception as your primary residence for it to be considered your investment / rental. This would help some people I know. thanks for the heads up!

Nov 07, 2007 12:38 AM

Nancy Moeller

Seven Gables Real Estate - Anaheim Hills, CA

Scott - great post. My question is about basis. My understanding is that your investment basis is the current value on the date of conversion to a rental property in which case any loss to date would not be deductible unless you could gain an appraisal above true market value, which is a possibility in a market like this.

Nov 07, 2007 02:12 AM

The TaxMan

Self Employed - Oakland, CA

Nick, I don't have any experience with and can't offer any advice about anything that has anything to do with Florida.

But, from my understanding (and correct me if I am wrong), the Homestead Exemption allows you to deduct $25,000 from the assessed value of your primary home for property tax purposes which basically, depending on who you are, saves you like $500-750 annually.

I think it only affects your property tax, so I don't see why you can't claim the homestead exemption.

Here's my reasoning, and here's the IRS link for some more reference:

As far as selling it goes after it becomes a rental, the sooner you do it, the more likely you are to get audited, so I would recommend holding onto the property for a little while before selling it (as any business transaction structured only for the purpose of tax avoidance can be harshly punished by the IRS).

For time limits, anything rented longer than 14 days is considered taxable rental income, so that shouldn't be too difficult to satisfy. A rental property is considered a rental once it is available for rent (placed in service date, or conversion date in this case), so generally, the time limits aren't that big of a deal. Your rental expenses (mortgage, depreciation, property tax *homestead, etc...) get prorated for the period of time the property was rented, but that's not a big deal because you get to deduct some of the remaining personal portion on your schedule A Itemized Deductions. Obviously you can't move out of your house, rent it out for two months, sell it and call it a rental loss.

The thing to keep in mind however is that estate losses are subject to a yearly $25k limit depending on your AGI unless you are a real estate professional or materially participate, in which cases the losses are unlimited........AND, your real estate losses in most cases cannot offset your regular income (passive activity) so you usually have to have some other type of rental income to offset the loss with.

Nov 07, 2007 05:00 PM

The TaxMan

Self Employed - Oakland, CA

Nancy, I think your perspective of basis differs quite a bit from mine.

As far as I know, your investment basis is NOT the current value on the date of conversion. The investment basis is what you have invested into the basis, which becomes your depreciable basis. Minus the cost of land (which cannot be depreciated), your investment basis is your basis for depreciation.

The easiest way to calculate the depreciable basis is using the property's closing statement, adding the Contract Sales Price along with other fees like title and settlement charges, minus land, plus capital improvements that you have made to the property.

The same method is used to calculate the adjusted cost basis for 1031 exchanges.

As a result, an appraisal will not have any effect on the loss you can claim on real estate, as it does not relate to the value of your investment which was determined long before the appraisal.

Nov 07, 2007 05:33 PM

Nick M.

Certified Residential Appraiser- West Palm Beach Real Estate - West Palm Beach, FL

Realtor-Appraiser in West Palm-South Florida Real Estate Appraiser

thanks for your response Tax Man, I'll look into the link you provided. Appreciate your time! :)

Nov 09, 2007 12:23 AM

Nancy Moeller

Seven Gables Real Estate - Anaheim Hills, CA

I would love to be wrong the point of basis so I researched it a bit more. Please let me know how you support your position, because if it'll fly, I'll definitely add it to my arsenal.

From IRS Pub. 17

If you hold property for personal use and then change it to business use or use it to produce rent, you can begin to depreciate the property at the time of the change. To do so, you must figure its basis for depreciation. An example of changing property held for personal use to business or rental use would be renting out your former personal residence.

Basis for depreciation. The basis for depreciation is the lesser of the following amounts.

The FMV of the property on the date of the change.
Your adjusted basis on the date of the change.

Then if you sell it for a gain, you use your adjusted basis as of the date of sale. But if you sell it for a loss, you are still supposed to use the lessor of the FMV on the date of change or adjusted basis at the time of change (plus subsequent adjustments).

http://www.irs.gov/publications/p17/ch13.html

Nov 09, 2007 01:38 AM

The TaxMan

Self Employed - Oakland, CA

Nancy, you are absolutely right.

The basis is the lesser of:

FMV or Adjusted Basis.

And the adjusted basis is usually always lower than FMV, and vice versa, FMV is almost always more than your basis.

I'm a little more conservative, so I never really use the FMV. If market values are much too low, then that's a different picture.

Thanks for bringing this to my attention.

Nov 09, 2007 11:49 AM