My sister purchased some property in Florida at the peak in 2005.

It's now worth about two thirds of what she paid for it. If she sells

it at a loss, she can't deduct the loss because it was for personal

use.

But suppose she rents for a while. When she depreciates the property,

can she depreciate it from her cost basis or from its current value?

How long must she rent it before it becomes "income" property that is

deductible when sold at a loss? Assuming she's owned it for four

years, but sells it two years from now, how much of the "loss" can be

deducted (or used to offset capital gains)?

The gain/loss on sale of house will be based upon the depreciable

basis, which is the lower of cost or FMV. So if she purchased for 1M,

and it was worth 600k when she started renting it, and she sells it

for 750k 3 years later, she has a gain of 150k plus the recaptured

depreciation (about 600k/27.5=21.81k per year, or 65.45k over 3

years), so we're looking at 25% of 215.45k or 53.86k in tax. That's

federal tax only on the sale of business property, though the rate

could be lower than 25% in some cases. There's state tax too.

Florida has no personal income state tax, but if your sister lives in

CA, CA will want 9.55% of this 215.45k.

How much rental profit could she make in 3 years? From what I'm

seeing in the Bay Area, if one has a mortgage outstanding on 65% of

the original purchase price and the house was purchased a few years

ago during the boom, then with expenses excluding depreciation --

mortgage interest, property tax, condo fees, professional management

fees -- the rental is a net loss because the rent does not cover the

expenses. On the other hand if one has no mortgage there will likely

be a gain, but after depreciation there could still be a loss.

Suppose the rent is $4000 a month. Suppose no mortgage, property tax

$600 per month, condo fees $400 per month, management fees 6% of $4000

or $250. Net profit before depreciation is $2750. Depreciation is

600k/27.5=21.81k per year, or 1.8k per month, so net profit is $950

per month. Assuming 1/3 of that is used to pay federal tax, we have

to pay about $315 per month in federal taxes. Cash flow is $2750 per

month, minus the $315 in taxes, or $2435 net per month, which is a

little less than 90k over 3 years. About 60% of this 90k will be used

to pay the 25% of 215.45k tax noted above, which is tax on the sale of

business property.

Of course, rents will increase over the 3 year period that you're

renting it, but in our recession the increase will be slight or not at

all. And it's doubtful that the house would appreciate 25% in 3 years

(from 600k to 750k). So what I'm saying is that if you start renting

now and hold it for only 3 years, you'll likely lose even more through

the payment of taxes.