Lost deposit on proposed rental purchase

[LLTS]

Taxpayer put 10,000 down on a rental property. Financing
fell through and he eventually lost his deposit. Misc
subject to 2% on Sch A?? Anyone have any ideas?

 

[D. Stussy]

Taxpayer put 10,000 down on a rental property. Financing
fell through and he eventually lost his deposit. Misc
subject to 2% on Sch A?? Anyone have any ideas?

Not deductible at all. Had the transaction gone through, it
would have been a capitalized amount. As no asset was
actually acquired, there will be no deduction upon
disposition either (nothing to dispose).

 

[Seth Breidbart]

LLTS wrote:

Not deductible at all. Had the transaction gone through, it
would have been a capitalized amount. As no asset was
actually acquired, there will be no deduction upon
disposition either (nothing to dispose).

Since the attempted purchase was for business purposes, I'd
say it should be deductible.

Perhaps it could be considered an option that expired,
yielding a short-term capital loss.

Seth

 

[Harlan Lunsford]

LLTS wrote:

Not deductible at all. Had the transaction gone through, it
would have been a capitalized amount. As no asset was
actually acquired, there will be no deduction upon
disposition either (nothing to dispose).

Here was a transaction entered into with a profit motive.
And as such, he has a capital loss. Don't you think?
sure wasn't a personal loss.

ChEAr$,
Harlan Lunsford, EA n LA

 

[A.G. Kalman]

LLTS wrote:

Not deductible at all. Had the transaction gone through, it
would have been a capitalized amount. As no asset was
actually acquired, there will be no deduction upon
disposition either (nothing to dispose).

Why isn't this an expense incurred to produce income that
must be included in gross income? Sounds like a Line 22
Schedule A deduction to me. It was rental property not a
personal residence.

 

[D. Stussy]

Why isn't this an expense incurred to produce income that
must be included in gross income? Sounds like a Line 22
Schedule A deduction to me. It was rental property not a
personal residence.

If you feel that you can make that argument (and deduct it
pursuant to Section 212 - production of income), go ahead.
However, I note that this was an amount expended for the
acquisiton of an asset (that was not actually required), and
that requires capitalization - but as there's nothing to
capitalize the expenditure into, there's no provision under
which it would be deductible.

As for Schedule A, line 22, I must disagree. As the
original question claims a connection to rental property AND
as capital asset transactions (sales) both are "above the
line" type transactions, Schedule A is the wrong place for
it. An aggressive approach would place it onto Schedule E,
but I bet that Schedule D (with the $3k capital loss limit)
would be considered by the IRS upon audit if outright
disallowance isn't taken as their position.

 

[Harlan Lunsford]

If you feel that you can make that argument (and deduct it
pursuant to Section 212 - production of income), go ahead.
However, I note that this was an amount expended for the
acquisiton of an asset (that was not actually required), and
that requires capitalization - but as there's nothing to
capitalize the expenditure into, there's no provision under
which it would be deductible.

(snipped)

The moment the deposit on the property is made,
capitalization de facto occurs. And that is what qualifies
it for capital loss deduction when the deposit is not used
and thus results in an exchange, zero being the proceeds.

I'd take the capital loss in a Noo Yawk minute.
(I think that's the expression they use.)

ChEAr$,
Harlan Lunsford, EA n LA

 

[LoTax]

If you feel that you can make that argument (and deduct it
pursuant to Section 212 - production of income), go ahead.
However, I note that this was an amount expended for the
acquisiton of an asset (that was not actually required), and
that requires capitalization - but as there's nothing to
capitalize the expenditure into, there's no provision under
which it would be deductible.

As for Schedule A, line 22, I must disagree. As the
original question claims a connection to rental property AND
as capital asset transactions (sales) both are "above the
line" type transactions, Schedule A is the wrong place for
it. An aggressive approach would place it onto Schedule E,
but I bet that Schedule D (with the $3k capital loss limit)
would be considered by the IRS upon audit if outright
disallowance isn't taken as their position.

I am absolutely sure there's a better answer to this
often-encountered situation than "maybe, maybe not." I'm
just not in a position right now to ferret it out.

 

[Stuart A. Bronstein]

The moment the deposit on the property is made,
capitalization de facto occurs. And that is what qualifies
it for capital loss deduction when the deposit is not used
and thus results in an exchange, zero being the proceeds.

I'd take the capital loss in a Noo Yawk minute.
(I think that's the expression they use.)

Yeah, but you have to register first.

Stu

 

[Stuart A. Bronstein]

D. Stussy wrote:

I am absolutely sure there's a better answer to this
often-encountered situation than "maybe, maybe not." I'm
just not in a position right now to ferret it out.

How about adding it to the basis of the new property the
taxpayer eventually does buy?

Stu

 

[D. Stussy]

How about adding it to the basis of the new property the
taxpayer eventually does buy?

How about I deduct all my food and other personal expenses!

How would that be a capitalizable expense into the property
actually acquired? The amount was not expended to acquire it
but as an attempt to acquire something else.

Not every transaction is deductible (somehow) under the IRC.

 

[Harlan Lunsford]

How about adding it to the basis of the new property the
taxpayer eventually does buy?

No, because it's not the same property.

ChEAr$,
Harlan Lunsford, EA n LA
Wednesday June 14th, 06

 

[A.G. Kalman]

(snipped)
The moment the deposit on the property is made,
capitalization de facto occurs. And that is what qualifies
it for capital loss deduction when the deposit is not used
and thus results in an exchange, zero being the proceeds.

I'd take the capital loss in a Noo Yawk minute.
(I think that's the expression they use.)

I have to take issue with this conclusion. This was not a
completed sale. This was nothing more than an executory
contract. Having failed to comply with the terms of the
contract the deposit was lost. There is no de facto
capitalization of a deposit on an executory contract. This
would seem to imply that the receiver of the deposit would
have taxable income!

I will stick with my conclusion that the sale not having
been completed leaves the potential buyer with an ordinary
loss that can be taken on Schedule A subject to the 2% AGI
limitation.

 

[Stuart A. Bronstein]

I have to take issue with this conclusion. This was not a
completed sale. This was nothing more than an executory
contract. Having failed to comply with the terms of the
contract the deposit was lost. There is no de facto
capitalization of a deposit on an executory contract. This
would seem to imply that the receiver of the deposit would
have taxable income!

Why wouldn't the receiver of the deposit have taxable
income?

When a deposit is made it's basically a part of the
investment. For whatever reason the investment became
worthless.

Stu

 

[Harlan Lunsford]

I have to take issue with this conclusion. This was not a
completed sale. This was nothing more than an executory
contract. Having failed to comply with the terms of the
contract the deposit was lost. There is no de facto
capitalization of a deposit on an executory contract. This
would seem to imply that the receiver of the deposit would
have taxable income!

I will stick with my conclusion that the sale not having
been completed leaves the potential buyer with an ordinary
loss that can be taken on Schedule A subject to the 2% AGI
limitation.

then we DO agree; to disagree.

As for the receiver of the deposit, yes, I think he does
have taxable income, short term capital gain probably.

ChEAr$,
Harlan Lunsford, EA n LA
Thursday June 15th 2006

 

[MTW]

I will stick with my conclusion that the sale not having
been completed leaves the potential buyer with an ordinary
loss that can be taken on Schedule A subject to the 2% AGI
limitation.

Pardon me jumping in here late.

I think one would need to carefully research the nature of
the "deposit" and specifically ~why~ it was lost. But, in
general terms, assuming that the deposit would have been
applied as part of a down payment had the transaction
succeeded, I would consider it a short term capital loss. I
say "capital" on the assumption that the failed transaction
would have the same character in this regard as if it had
succeeded. (By the same thinking, if the prospective
purchaser of the realty was a DEALER, then I'd guess the
loss to be "ordinary.")

However, I think the larger issue - and the one that the IRS
might be more likely to pursue if the loss came up on audit
- is establishing that there was truly a business or
investment intent with respect to the transaction. I'm sure
the IRS would try to argue that it was "personal" in nature
and therefore no loss was allowed.

MTW

 

[123go]

I have to take issue with this conclusion. This was not a

completed sale. This was nothing more than an executory
contract. Having failed to comply with the terms of the
contract the deposit was lost. There is no de facto
capitalization of a deposit on an executory contract. This
would seem to imply that the receiver of the deposit would
have taxable income!

of course they would have taxable income. It wasn't a gift.

 

[LoTax]

A.G. Kalman wrote:

Pardon me jumping in here late.

I think one would need to carefully research the nature of
the "deposit" and specifically ~why~ it was lost. But, in
general terms, assuming that the deposit would have been
applied as part of a down payment had the transaction
succeeded, I would consider it a short term capital loss. I
say "capital" on the assumption that the failed transaction
would have the same character in this regard as if it had
succeeded. (By the same thinking, if the prospective
purchaser of the realty was a DEALER, then I'd guess the
loss to be "ordinary.")

However, I think the larger issue - and the one that the IRS
might be more likely to pursue if the loss came up on audit
- is establishing that there was truly a business or
investment intent with respect to the transaction. I'm sure
the IRS would try to argue that it was "personal" in nature
and therefore no loss was allowed.

Twenty years ago, I researched this very very diligently,
and well-motivated, and - as best I can recall - this should
be characterized as an *ordinary* loss, and reported on page
one of 1040. It's not a *capital* loss since it's neither a
sale nor an exchange and it's not susceptible to the
artificial capital loss "option" treatment(s) under IRC
section 1234 or somewhere around there in the code. I am
unable to retrieve the research now, but I would suggest
someone might want to look into the abandonment of a
partnership interest where there's no proceeds, not even
"deemed" proceeds from liabilities, as an analogy. IRS
published a ruling accepting the partnership situation as an
ordinary loss, and IIRC there's a parallel between these
scenarios. In addition, there's no such thing as
"short-term section 1231 loss" which is where this - maybe,
memory's failing - ends up in an alternative argument.

Sorry my archives are in such disarray; I might have been
able to pull this up a few years ago.

 

[Seth Breidbart]

As for the receiver of the deposit, yes, I think he does

have taxable income, short term capital gain probably.

Though if he's selling the property and the sale completes
(to another buyer) in the same year, could the forfeited
deposit be consider part of the sale proceeds (making it
long-term)?

Seth

 

[A.G. Kalman]

Why wouldn't the receiver of the deposit have taxable
income?

When a deposit is made it's basically a part of the
investment. For whatever reason the investment became
worthless.

Maybe I should have been clearer in my reply. At the time
of the deposit, we have an executory contract. The receiver
of the deposit has no taxable income as there is no
completed sale. There is nothing to capitalize on the part
of the taxpayer making the deposit. After the default,
there is taxable income to the taxpayer that received the
deposit and there is a deductible loss to the taxpayer who
lost the deposit.